As the eyes of the world turn on Japan during the troubled Tokyo Olympic Games, investors will be wondering whether its stock markets can still deliver gold.
The last time its markets led the field was back in the 1980s, when the Nikkei 225 flew to the dizzying height of 38,957.44 on December 29, 1989, during what is now known as the Japanese asset price bubble.
That figure, achieved more than three decades ago, remains its all-time high. In the subsequent crash, it lost around 80 per cent of its value and slipped towards 7,000 during the financial crisis in March 2009.
Investors who gave up on Japan as it suffered one “lost decade” of growth after another may be surprised to discover the market is finally making up lost ground, hitting a 30-year high of 30,467.75 on February 16.
The country still boasts plenty of household name brands, especially in cars and electronics, including Toyota, Mitsubishi, Honda, Nissan, Sony, Nintendo, PlayStation, Panasonic and Hitachi.
Many retail investors will have no direct exposure to Japan in their portfolios, but now could be a good time to take a return trip to the land of the rising sun.
The Covid-19 pandemic has hit every country, but you have to feel sorry for Japan. The country has invested an estimated $15.4 billion into hosting the 2020 Olympic Games, with private companies investing another $4.08bn.
Big sporting events are an opportunity for the host nation to show the world what it has got, but the economic boost from tourism has evaporated, Jason Hollands, managing director of UK investment platform Bestinvest, says.
“Prime Minister Yoshihide Suga has extended the state of emergency, with no fans allowed at the events,” Mr Hollands says.
Despite this bad luck, investors should consider increasing their exposure to what is still the second largest stock market in the world after the US, totalling 5.9 per cent of the MSCI World Index, Mr Hollands says.
Some will have had their fingers burned in the 1980s bubble, which was fuelled by excessively loose monetary policy, then followed by a prolonged period of stagnation.
Others will be deterred by Japan’s ageing population. With a medium age of 48.6 years, it is the oldest in the world. Low fertility rates mean that by 2065, the population is expected to shrink by a third. This means a smaller workforce and lower taxpayer base, as well as higher social, medical and care costs.
Investors need to separate the challenges facing Japan's domestic economy from the opportunities enjoyed by its top international companies, Mr Hollands says.
The Japanese market looks reasonably valued, with companies trading at 15.3 times projected earnings, below the 18.7 times for global equities and 21.6 times earnings for US shares.
Forecast earnings growth also looks healthy, Mr Hollands adds, with earnings per share expected to grow 28.1 per cent this year and another 11.8 per cent in 2022 as global demand picks up for Japanese exports.
Japan could steal a lead in the post-Covid-19 recovery, boosted by the global tech recovery and rebounding car production, John Vail, chief global strategist at Nikko Asset Management, says.
Even the Olympics and Paralympics could ultimately work in its favour.
“Japan will be globally lauded for hosting it during troubled times, aiding political stability leading into the country’s general elections in the autumn,” Mr Vail says.
The economy should enjoy a further boost as its sluggish vaccine programme picks up speed, while the inflation panic sweeping much of the world is less likely to gain traction in this deflationary land and might even be welcome.
The Nikkei’s rebound follows 30 years of underperformance and the market is still relatively cheap, Paul ffolkes Davis, chairman of Rising Sun Management, says. “We have a long way to go before any aspect of the Japanese market is fully valued.”
The country is finally delivering long-awaited corporate governance reforms and Darius McDermott, managing director of FundCalibre, says it remains business-friendly and politically stable.
Japan should also be pulled along by its fast-growing Asian neighbours, while the Covid-19 pandemic may bring much-needed change by forcing the country’s more conservative businesses to move online, Mr McDermott says.
“This will open up opportunities in a wide range of areas including e-commerce, software-as-a-service, digital payments, wealth management, insurance and real estate.”
Compared with the West, Japanese company dividends have remained relatively resilient during the Covid-19 pandemic. The market currently yields 2.2 per cent, above the US S&P 500’s current 1.35 per cent, although below the UK FTSE 100’s 3.5 per cent yield.
Japanese companies have exceptionally strong balance sheets and with cash to spare, a third now plan to increase shareholder payouts, Mr McDermott says.
There are plenty of low-cost exchange traded funds targeting Japan, including iShares MSCI Japan ETF, JP Morgan BetaBuilders Japan ETF, WisdomTree Japan Hedged Equity Fund and Franklin FTSE Japan ETF.
Investors may also want exposure to its thriving smaller companies sector through ETFs such as WisdomTree Japan SmallCap Dividend Fund and iShares MSCI Japan SmallCap ETF.
Japan has been slow to tackle climate change but now the government is urging action and this could boost the country’s environmental, social and governance (ESG) investment sector. Investors could play this with the Xtrackers ESG MSCI Japan UCITS ETF, which screens companies for carbon exposure, alcohol, gambling, weapons, tobacco and nuclear power.
Don’t rule out actively managed funds, Mr McDermott says, as the market is under-analysed and this throws up opportunities for alert stock pickers.
Fund managers Fidelity, T. Rowe Price, Matthews, Baillie Gifford and JPMorgan offer Japanese mutual funds that may be available in your investment jurisdiction.
Investors should also consider publicly quoted investment companies trading on the London stock market, whose business is to invest in Japanese stocks, Dzmitry Lipski, head of fund research at Interactive Investor, says.
“Baillie Gifford Shin Nippon wins gold over 25 years, with a total return off 689 per cent, while Baillie Gifford Japan came second by returning 613 per cent. Over five years, Fidelity Japan Trust returned 105 per cent."
Naturally, there are risks to investing in Japan. Some fear the country has overdone the fiscal and monetary stimulus and its recovery could come to a swift end once this is withdrawn.
The pandemic has also forced Japan to review its role as a global export powerhouse.
“Businesses are now questioning the benefits of supply chain globalisation. The global scramble for low-tech medical supplies like personal protective equipment has alerted companies to the need to shorten distances within supply chains and reduce dependence on hostile suppliers,” Taeko Setaishi, investment adviser to the Atlantis Japan Growth Fund, says.
Many companies are reshoring production. “Rather than producing in low-cost locations and selling globally, companies such as Canon, Casio and Honda are shifting to a ‘local production for local consumption’ model.”
This will require heavy investment in production and supply chains, including AI-based logistics systems, but may also deliver productivity benefits, Mr Setaishi says.
The Japanese IT, chemicals, materials and construction sectors are likely to benefit from long-term structural trends such as digitalisation and decarbonisation, Eiji Saito, portfolio manager of JPMorgan Japan Small Cap Growth & Income, says.
Japan may have lost its opportunity to showcase its leading technologies and tourist attractions during the Olympics, but it may soon get a second opportunity to impress, Richard Aston, fund manager of CC Japan Income & Growth Trust, says.
“We hope that the World Expo in Osaka in 2025 will go ahead as planned.”
Private investors should also give Japan a second chance. While the population is inexorably ageing, its corporate sector remains fresh and vital.
