Japan’s broad Topix index reached their highest in 33 years last week and is up 10.6% in USD terms this year1. The market’s ascent is sweet vindication for investors who have kept the faith. Eastspring’s Japan equity team has long pointed to the market’s cheap valuations, potential for corporate reforms and improving profit margins as reasons to be positive. These factors may finally be gaining traction with investors.
At 1.3x price to book valuation2 , Japan is more attractively priced than the US, European and Asia ex Japan markets. This is despite Japan’s cash earnings, as measured by the cash earnings yield, being superior. Profit margins are also trending higher on the back of efficiency gains. Improving corporate governance is another key structural change for the Japanese market. There has been a rising representation of independent directors on company boards over the years, including a number of activist fund managers on the boards of prominent companies. 77% of the companies in the Topix have independent directors that make up at least one third of their boards 3. A greater focus on shareholder value has been accompanies by a rise in dividends and share buybacks. More recently, new rules for the Tokyo Stock Exchange require companies that persistently trade below their book value to disclose plans to remedy the situation. This may encourage companies to exert greater effort to increase their corporate value.
On the macro front, pent up domestic demand from Japan’s re-opening in the first half of the year, the positive spill over from China’s re-opening and the removal of supply constraints will help support the Japanese economy in 2023. While weak exports would weigh on the Japanese economy going forward, the stronger than expected wage hikes from the recent spring wage negotiations may help sustain consumer spending. Wage hikes can make consumers more tolerant of higher prices, potentially leaving room for companies to raise prices. Consumer price inflation has been above 2%, the Bank of Japan’s target since April 2022. If sustained, this could spell the end to Japan’s decades of deflation, potentially positioning private demand as an important driver of economic growth.
Eastspring’s Japan equity team continues to be disciplined in seeking mispriced companies and focusing on companies’ sustainable cashflows. While the market has rallied, the good news is that Japanese value stocks are still trading at an attractive discount to Japanese growth stocks. While there could be some bumps along the way, further potential upside awaits the patient investor.
