After outperforming in the first half of 2024, Japanese stocks have had a few volatile months. First, growing worries in July about a global economic slowdown pressured Japanese stocks. A “shock” market event followed in which the “yen carry trade”—when one borrows in yen at low interest rates to fund investments in a higher interest rate currency—abruptly unwound, sending Japanese stocks cratering overnight. Stocks rebounded quickly only to see another round of uncertainty creep in as a change in Japan’s political leadership led to questions about the country’s fiscal and monetary policy. The snap parliamentary elections and the losses for the ruling Liberal Democratic Party (LDP) party in late October introduced new potential worries. (See Exhibit 1.)
While short-term moves like these can be unnerving, over the longer term, we continue to believe there is value to uncover across the Japanese stock market as inflation returns, real wages inflect and rise, and corporate governance reforms progress, driven by the Tokyo Stock Exchange’s (TSE’s) push for companies to get their book values above one.
Exhibit 1: MSCI Japan Outperformance Has Faltered
Changing political leadership
After Shigera Ishiba became LDP leader in late September and prime minister at the start of October, a snap election in late October cost the LDP its parliamentary majority for the first time since 2009. Despite the loss of its majority, the LDP will remain in power, continuing Japan’s recent economic progress and corporate reforms.
As a result, Abenomics, the policies implemented by late Prime Minster Shinzo Abe which have been seen as helping Japan finally reverse years of stagnation, should largely continue. These policies have called for loose monetary policy, fiscal spending and structural economic reforms. Although rates are rising, and we expect continuing interest-rate normalization over time, monetary policy remains relatively loose when compared to other developed markets.
However, we may see modest changes in priority given the changing politics. Ishiba has favored higher corporate and capital gains taxes, efforts to revitalize rural Japan, a higher minimum wage and spending to cushion the impact of higher prices. As attention turns to upper house elections next year, Japanese policy could veer toward greater fiscal spending in the short term to bolster the economy.
Japanese economic fundamentals strengthening
Improving Japanese economic growth remains a necessary priority for any new government. We see few signs that either the United States or global economies are tipping into recession this autumn, but some indicators have shown slowing. The US Federal Reserve’s 50 basis point interest rate cut in September and 25 basis point cut in November may give the US economy, and therefore the global economy, some support.
The International Monetary Fund (IMF) anticipates 3.2% global gross domestic product growth this year and next.1 US expansion may slow in 2025, according to the IMF, but Europe and Japan should see a pickup.
With the prospects remote for a major global recession, we believe fundamentals in the Japanese economy and stock market remain encouraging for value investing.
The Japanese economy appears to us to be emerging from years of stagnation. A rebound in goods and wage inflation should help the country boost economic dynamism and spark a period of hotter and more sustained growth. (Exhibit 2) Furthermore, Japan’s largest labor union group is seeking another 5% wage increase for members in 2025 after a sizable raise in 2024, reinforcing the positive economic outlook. Overall, the pace of wage gains across Japan have been increasing, rising at a 2.6% year-on-year pace in September after a 2.4% pace in August, according to the Japanese Ministry of Health, Labor and Welfare.
Exhibit 2: Japanese Consumer Prices Have Increased Year-over-Year
Additionally, we believe that the Bank of Japan will continue to gradually normalize monetary policy over the next couple of years, regardless of the political environment, as higher wages help end falling prices and stagnant incomes.
Companies embracing change
Corporate Japan is beginning to adopt change at the same time the economy moves to stronger growth and modest inflation. The Tokyo Stock Exchange (TSE) is encouraging companies to improve their returns and reduce their cost of capital as part of a push to make the country more investable. The Japanese market is rife with companies trading at book values below one, with the average price-to-book ratio on the Prime Tokyo Stock Exchange at 1.2 times and on the standard market at 0.8 times as of October 2024, according to data from the TSE.2 This compares with a price-to-book ratio of nearly 4.5 times for companies in the S&P 1500, according to data from S&P.3
The TSE is also pushing companies to reduce their cross-shareholdings, which are widely seen as a barrier to market efficiency and transparency, as well as a barrier to mergers and acquisitions.
We have begun to see several big companies, like Toyota Motors, begin to unwind holdings in related firms. Those companies with clear plans to improve returns and reduce their cost of capital, and that are willing to buy back stock trading below book value following the unwinding of cross shareholdings, are particularly appealing for more intense analysis, in our opinion.
Focus on valuation and catalysts
In our view, sifting through the Japanese market can uncover stocks trading at attractive valuations and that are willing to embrace structural changes. Greater certainty around economic, fiscal and monetary policy following the recent election can further help unlock value. We believe that an improving economy and faster wage growth may create long-term value opportunities particularly in domestically focused companies and that the Japanese market continues to have long-term appeal for stock picking.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Value securities may not increase in price as anticipated or may decline further in value. Growth or value as an investment style may become out of favor, which may have a negative impact on performance.
Active management does not ensure gains or protect against market declines.
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1. International Monetary Fund, World Economic Outlook Update. October 2024. There is no assurance that any estimate, forecast or projection will be realized.
2. Source: Tokyo Stock Exchange. As of October 2024.
3. Source: S&P Dow Jones Indices. As of October 31, 2024.
