Waking up the SLEEPING Giant

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The sleeping giant in the East may be awakening as Japan's stock market moves above levels last seen more than thirty years ago. This "drastic" change in the market has, however, not occurred overnight, but rather began in 2014 when the late Shinzo Abe launched his new program to reform the market by reinvigorated corporate governance and corporate cultures. The sea of change was brought about by structural reforms, started as part of "Abenomics," which have taken effect over the last decade. This year, the long-time governor Haruhiko Kuroda (who began his post in 2005) was replaced by Kazuo Ueda, an academic from Tokyo University. As a matter of coincidence, the Japanese market broke through key resistance levels at the beginning of his term in office.

Japan Stock Exchange Narrative shift

Several key changes have taken place to kickstart growth in Japan including pay raises, dividend increases, share buybacks, and increased focus on diversity of management teams and company boards.   

While this shift began with Shinzo Abe and his structural reforms, it has continued with a number of more recent key policy changes. Some of which include:  

• The Tokyo Exchange Group's new rules and guidance which includes a "comply or explain" requirement for companies with a P/B of one or below. 
• Recent updates to the Corporate Governance and Stewardship code which seek to enhance governance and improve engagement to foster growth and value creation. 
• Increased emphasis on timely and accurate disclosures aimed at improving investor confidence. 
• Strengthening shareholder rights by improving the proxy voting system, index inclusion criteria and share buyback procedures.

The changes and reforms demonstrate a broad push to a more shareholder-centric approach which should continue to result in more efficient markets and better investment flows for equities. 

Earnings have also been improving paired with the favourable economic conditions in the face of ultra-low interest rates, weaker currency, and a rebound in consumer spending and tourism following the pandemic. Japan's nominal GDP growth is predicted to approach 5% in 2023, its highest since 1991. The nominal growth trend is then predicted to shift up above 2% over the medium term.  This could create a cycle that supports calls for higher employee compensation, improved corporate earnings, better tax revenues, and a resultant positive impulse for asset prices.

Read also: What is driving Rand depreciation?

Central Banking Changes

The Bank of Japan hasn't been idle in trying to support the stock market and the economy either. In fact, it has been very involved, sometimes even blurring lines between monetary and fiscal policy, and breaking records for interventions in terms of number and sheer sizes. The BoJ even instituted quantitative easing through targeted purchases of domestic stock ETFs (namely the Nikkei 225 and 440) to support asset prices and reduce the cost of capital for domestic companies. This included an annual target of $55bn of ETF purchases that was maintained for almost a decade resulting in the BoJ becoming the biggest owner of Japanese stocks (holding more than +$400bn).

In the fixed income markets, Kuroda implemented Yield Curve Control (YCC) aiming to control the yield curve by setting limits on the 10y yields. This was achieved through targeted purchases that ensured that lower rates levels were maintained. The goal of YCC was to boost economic activity and lower borrowing costs. Economists expect tweaks of the YCC in July which may come in the form of another 25-bps adjustment of the band. Essentially, this means that the BoJ will buy up 10y JGBs where the yields spike above the predetermined level. YCC is costly and puts downward pressure on the Yen by making Japanese debt less attractive (which results in less demand for the currency).

The BoJ has also taken part in several FX interventions to prop up the Yen. The first intervention was in 1998 around the 145 Yen/Dollar level which was the level also supported last year and briefly touched upon this year.

Conclusion

One should always consider how the narrative in markets may change overtime especially as geographic diversification has been somewhat shunned over recent years following outperformance in selected markets (such as the US). It is, however, prudent to continue to rebalance and manage allocations within a portfolio to maintain global diversification and a robust risk management process over the long run. Long-term investing and weathering uncertainty can be a difficult process, but a globally diversified portfolio can reduce risk and capitalise on opportunities that may be further away from home. Japan may well be one such opportunity.

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