Sarah Whitley, Manager, Baillie Gifford Japan Trust.
Despite good performance in 2013, Japan remains a controversial market for many and the beginning of 2014 seems to have elicited negative analysis from a variety of commentators. It is clear that a bullish consensus has yet to emerge, despite the many positive changes within Japan. This article will try to set out the reasons for our continued optimism.
The LDP, historically the main party in power, were re-elected at the end of 2012 with a mandate to implement ‘Abenomics’. This is a wide ranging programme to revitalise the Japanese economy and raise its growth rate in the long term, as well as provide short-term stimulus. During the past year the yen has weakened significantly, allowing Japanese manufacturing to be re-priced into world markets, company sentiment has improved tremendously and there are encouraging signs that growth is spreading into the broad domestic economy. Unemployment in Japan is low and falling and the index of job offers to applicants is above parity i.e. there are more openings than candidates. A recent announcement that the 2020 Olympics would need 1m construction workers led to one of the first official comments on the need to raise immigration as there are not 1m unemployed in Japan. Additionally, inflation is low and rising, which is positive in the context of historic deflation, although there remains scepticism about the achievement of the 2% inflation target. Winter bonuses rose and pressure to raise base wages is building.
Whilst the first arrow of Abenomics, Japan’s move to quantitative easing, has been relatively straightforward after a new Governor of the Bank of Japan was appointed in April, the third arrow of deregulation is inherently more complex. There was a flurry of legislation passed by the Diet as part of the third arrow at the end of 2013, including one of the two enabling bills for Casinos. The deregulation that is needed conflicts with many vested interests and progress in some areas will be slow. There are however two catalysts for pushing forward change. One is Japan’s involvement in the Trans Pacific Partnership negotiations which would involve the formation of the world’s largest free trade area and the other is the 2020 Olympics which create a finite time scale for improvements. We believe the impact of both these changes is not well understood.
In the corporate arena there is a gradual changing of the guard in terms of who is influential. The last time the stock market had a strong rise internet entrepreneurs were being jailed, this time they are sitting on government panels and pushing for change. The attitude to mergers is also evolving. Last autumn Tokyo Electron, a highly regarded technology company, agreed to merge with Applied Materials in the US. This astonished most industry observers and signals a new attitude to bids from overseas. Subsequently a couple of takeovers, at least one foreign, have gone through without controversy. A more dynamic market in corporate control, allied with a gradual increase in attention to shareholder returns, is a structural positive for share prices.
2014 brings the rise in consumption tax (VAT) in April which will allow Japan to make its social security system, with fully funded pension sustainable, a significant achievement. A lot of attention is being focused on short term distortions to demand but the longer term implications are very positive. The government has also introduced ISAs, known as Nippon ISAs or NISAs, this month which should encourage the long-awaited switch from savings in bank deposits to equities as personal financial assets in Japan are huge, roughly 250% of nominal GDP, but little is currently invested in stock markets.
Overall there are many changes both in the economy and in less visible subtle sea-changes in attitudes which we believe are encouraging. It is not that ‘old’ Japan has vanished but it is smaller and less important and can be ignored, particularly by active investors such as ourselves. We continue to find exciting opportunities in internet related areas and in companies whose business model attacks the old and inefficient.