The past

It was 29 December 1989 when the Nikkei last hit an all-time high. At the time, I was a high school student, on a year’s stint as an exchange student in the US. Thanks to the strong yen, everything I bought seemed a bargain but, back then, Japan’s relationship with the US was nothing like the close ties that exist today.

Japan, then being the second largest economy, was viewed as a competitor and threat to US economic success. In the news, we saw Toshiba ‘boomboxes’ and Honda cars being destroyed by American workers. Indeed, Japan at that time – including its work culture – must have seemed foreign and alien. Japanese ‘salarymen’ were guaranteed lifetime employment, and lifelong dedication to the company was considered a virtue.

My father would leave home for work at 7am and typically returned after midnight, working six days a week. After a long day in the office, he was often expected to attend dinner and drinks with clients and colleagues, usually at corporate expense. The prevailing thought then was that companies belonged to the employees, not the shareholders. As a high school student in the late 1980s, my ability to enjoy the fruits of the burgeoning Japanese economy was limited, but I had the impression that the future was incredibly bright.

The recent strength in the Nikkei 225 Index is occurring under very different and challenging conditions compared to the golden era of the 1980s when Japan was riding high, having achieved the highest gross national product (GNP) per capita in the world, thanks to its technology-driven export-led growth and low unemployment. But this then led to investor exuberance and excessive valuations in the property and stock markets, with the asset ‘bubbles’ bursting in the early 1990s. Japan entered a period of economic stagnation known as ‘the Lost Decade’, caused by a sustained period of deflation (falling prices).

Why it took 35 years for the Nikkei to reach its recent level is worth considering, but the answer is simple – the peak in 1989 was just too high. Adjusting the inflated balance sheets from the bubble economy and bad loans, coupled with prolonged deflation, proved extremely difficult. Today, monetary and fiscal policies would have been deployed as a solution, but such methods were not available at the time.

Non-performing loans continued to be a major issue more than a decade after the bubbles burst, sacrificing funds that could have been better deployed into future investments. Additionally, the 1997/1998 financial crisis in Japan, which resulted in several bank failures, also hampered any progress. A comprehensive resolution requiring significant government capital injection was implemented in 2003, 14 years after the peak of the economic bubble. Later, China’s accession to the World Trade Organization in 2002 forced Japanese industries to lose competitiveness and undergo restructuring. Japan’s so-called ‘Lost Decade’ lasted for 23 years.

The present

35 years have passed since my high school days. It is my son who is now at high school, and he sees that the Nikkei Average is approaching the highest point in its history in a very different environment. He’s been astonished by the high prices in other countries during overseas trips. He notices his father is still working late into the night, but this seems to stem more from his fascination with fund management than anything else. He hears terms like ‘work-life balance’ regularly mentioned in the media as corporate culture is changing.

It is generally said that the country is losing competitiveness but there are still plenty of global companies in Japan. Toyota is the world`s number one automaker. Many semiconductor-related companies, which many industries cannot operate without, are also based in Japan. It is not just in business; Japan also is a centre of cultural attraction. In Shibuya, where my son changes train every day, we can see people from around the globe with smiling faces that are trying to get a shot of the famous Shibuya Crossing. It is worth highlighting that Japan remains one of the world’s largest economies, a pioneer in new technological and business processes, as well as having an influential role in cultural and global affairs.

Abenomics: a turning point

Former Prime Minister Shinzo Abe was tasked to turn around Japan’s sluggish economy and in late 2012 a series of economic policies known as ‘Abenomics’ were introduced. These policies included more liberal use of fiscal and monetary policy, as well as structural reforms to improve Japan’s competitiveness in global markets. This has really worked –  The TOPIX’s compound annual growth rate (CAGR) from December 2012 to the end of February 2024 was 14% in yen terms, which represents a strong return over the last 12 years.¹

New focus on shareholder returns and corporate governance

Abenomics was focused on solving Japan’s structural issues through accommodative monetary policy and market mechanisms. Companies were not just asked to earn profits, but to maximise them. For this purpose, the return on invested capital for each business was scrutinised, while withdrawal from low-profit businesses was encouraged.

First proposed in 2012, the Stewardship Code required institutional investors to be transparent about their investment processes, engage with investee companies and vote at shareholders’ meetings. The positive results of Abenomics can be evidenced by the following data: CAGR of net profit for the TOPIX during this period was 14% and the total return to shareholders was 12%.² Share buybacks became common and the total payout ratio has reached about 60%. Corporate governance reforms carried out in parallel have also shown results. Today, the number of companies with more than one-third external directors is almost 90%.

With numbers like that, the 14% CAGR registered by the TOPIX since the beginning of Abenomics in 2012 should be unsurprising.

And the future

Although Japanese companies have been evolving for the better over the last decade, we are only now seeing a revival of investor interest, helped by the decline in Chinese stocks and the lacklustre performance of the S&P 493 (S&P 500 minus the so-called Magnificent 7) in 2023.

In contrast to past decades, the majority of Japanese companies are now owned by shareholders rather than keiretsu banks or employees and management acting as if they own the companies. Profits are growing and corporate governance has been improving, while valuations remain reasonable compared to their historical average or relative to other markets.

Investors may want to reconsider an allocation to Japanese equities, a well-established, unique asset class offering both breadth and depth – the perfect set-up for a stock-picking approach.

 

Past performance does not predict future returns.

¹ Bloomberg, 30/11/2012 to 28/02/2024 in yen terms.

² Mizuho Securities Equity Research, as at 15 February 2024.