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Episode Description:
Long regarded as an undervalued and overlooked market, Japan has been undergoing a profound transformation. The renewed interest in this market stems from a variety of factors – including revamped investor sentiment, evolving macroeconomic conditions and compelling corporate reforms. Will Japan be able to live up to its potential and redefine its role on the global investment stage?
Belinda Boa, Head of Active Investments for Asia Pacific at BlackRock, joins Oscar to examine the prospects, challenges, and potential opportunities that may define Japan’s future in the global investment sphere.
Transcript
Oscar Pulido: Welcome to The Bid, where we break down what’s happening in the markets and explore the forces changing the economy and finance. I’m your host, Oscar Pulido.
Long regarded as an undervalued and overlooked market, Japan has been undergoing a profound transformation. The renewed interest in this market stems from a variety of factors, including revamped investor sentiment, evolving macroeconomic conditions, and compelling corporate reforms. And as global dynamics continue to recalibrate, will Japan live up to its potential and redefine its role on the global investment stage?
To help me answer that question, I’m pleased to welcome Belinda Boa. Head of active investments for Asia Pacific at BlackRock, Belinda will help me examine the prospects challenges and potential opportunities that may define Japan’s future in the global investment sphere.
Belinda, thank you so much for joining us on The Bid.
Belinda Boa: Hi Oscar. Thanks for having me.
Oscar Pulido: We’re here to talk about Japan, and I’m wondering if before we zoom in on the present and the reason that people are talking about Japan so much today, I wonder if we could zoom out and think about some of the standout moments that Japan has had over the past few decades and how have people thought about Japan just as a market to invest in?
Belinda Boa: Yeah. Japan was the poster child of the 20th century. Post-World War II, it grew a massive agricultural hub in the sixties. It was known for its engineering and its innovation in the seventies, and by the eighties, it was actually the second largest economy in the world. And the reason why I say that is not only that the economy was thriving, but so was the stock market.
December 1989 was the peak of the Japanese stock market, and at the time, Japan was 45% of the world’s market capitalization, it’s now six. Not only did it have an incredible run, it became an asset-inflated bubble economy.
Post December 89, just one year on from that, about 2 trillion was roughly knocked off the market capitalization of the exchange. That was roughly half its value. And from there, it entered two decades of very low economic growth, deflation and stagnation.
And the reason why it’s so important is that, when you have an environment of stagnation and deflation, for as long as Japan did, it creates a strong incentive for both corporates and for households not to invest and not to spend.
And so Japanese investors historically have been some of the most risk-averse in the world. Households today, still, most of their assets are in cash and in deposits. And up until recently, even corporates had very high cash balances. Lack of investment also meant that there was a lack of growth in the market. Roll on to the end of the nineties and beginning of 2000, the Japanese government, put forward some aggressive policies, some of which worked, but only for a short space of time. It was only in 2013 when Abenomics, which was really the economic term for the late Japanese leaders, revival of the Japanese economy had sort of three errors and the focus was monetary policy, flexible fiscal and then a structural reform story.
And the idea there was to reinvigorate growth to bring back inflation into the economy. So up until recently, we haven’t seen any of that, but that’s why I think we’re so excited about this transformational story that’s playing out in Japan because we are now seeing in the economy some of these efforts by policymakers and by corporates, which are really turning around what has been a very disinteresting environment for Japanese investors.
Oscar Pulido: Belinda, you mentioned a couple of really interesting things across that timeline that spans a few decades. I wrote down two numbers- 45 and six. You mentioned Japan was nearly half of the world’s market cap back at its peak in the late eighties, and today it’s less than 10% at single digits, so that suggests that Japan has lagged a number of global stock markets over the last 30-plus years. But you’re painting a picture that things are getting better, maybe talk a little bit more about this renewed investor optimism that really started in 2023.
Belinda Boa: Well, Japan has been both unloved and under-owned in global portfolios. And Oscar, you’re right, there was a good reason for that. When you’re in a deflationary environment with a lack of consumer confidence, a lack of spending, both at the corporate level and at the household level, it doesn’t generate the sort of returns that you’ve wanted, and that’s been the environment that actually characterized Japan. But there are some really big shifts that are happening, and I want to just focus on three of them.
Firstly, the macroeconomic environment. I mentioned that Japan has been in this deflationary spiral for a long time and for the first time, since mid 2022, we are starting to see inflation come back. This is going to have a profound impact on the behaviors of households and corporates. Because as opposed to always being in a cost-cutting exercise and worried about costs and not spending, actually, we are now seeing companies able to increase their prices. The impact of that is that we’re seeing margin expansion. So, this is profitable for companies and also, they’re able to spend not just on their own CapEx, but on wages.
So, we’re seeing wage inflation, you look at CapEx, you look at wage inflation. The numbers at the end of 2023 are at multi-decade highs. So, the macro environment is significantly different to where we’ve been and the impact that it’s having on corporates, on households, I think still has a long way to play out, but it’s very important because it’s so different.
Secondly, Japan is a diversifier. When you look at the rest of the world, we’ve been in an inflationary environment where inflation has remained stickier for longer, rates are higher for longer, and Japan’s policy is very different to the rest of the world. But that may change going forward. What’s also important to note is when you look at the stock market, it is very diversified. The US stock market is very concentrated in a number of tech names. Even A ex J when you look at Korea or Taiwan, has a very big concentration in semiconductors, and Japan is far more diversified. So, when you think about a global portfolio allocating to Japan, they really benefit from the resilience of low correlation driven by the macroeconomic policies, the economic environment, as well as the diversification of the index.
And then lastly, not only are we seeing investors globally interested in Japan, but also there’s been a very big shift from the government in terms of launching, a tax savings scheme for households. This is to encourage households to allocate from their significant cash holdings into securities. And while I think this is going to take a long time to play out, and we do understand that this is not only an allocation to purely Japanese equities, it is a very big shift from the environment we’ve been in where, like I said, households have held very large cash balances.
Oscar Pulido: So as of this month, we believe that the NISA scheme, which is going to be launched, is going to actually provide a separate tailwind to the Japanese equity market from domestic investors. You just reminded me I was going through my bookshelf this weekend and I came across a book that I read post the Financial Crisis in 2008, and it was titled This Time is Different and the authors were making the case that financial crises actually have repeated themselves over time. So actually this time is different are four very dangerous words to utter when it comes to financial markets because we tend to see a lot of these false starts and I think Japan has been characterized like that, before where you saw some of these ingredients that you mentioned maybe in place and then nothing manifested from it. But you’ve talked about inflation, you’ve talked about the role that it plays as a diversifier, policy changes, and so maybe this time, in fact really is different in terms of Japan’s revival. Can we talk about the geopolitical landscape and how does that affect the renewed interest in Japan?
Belinda Boa: This is a theme that we speak about a lot, particularly in this part of the world. We have been over the last decade in an era which can be described by geopolitical moderation, a globalization, and those terms, we’re not speaking about anymore. We’re in a world of global fragmentation. We are calling it the world in three, where we have the countries aligned with the West, countries aligned with China and the East, and then there is a large block of neutral political countries. These countries we think are going to benefit massively from the shifting trade patterns and shifting in supply chains.
So, when I look at trade numbers, trade’s not declining. Trade is just shifting, and it’s been driven by politicization, by a need for security. That’s true for governments, it’s true for companies as well. And we look at Japan, which has been very politically stable for many years. It has very close ties and allies in the West. And so as global companies are looking at rewiring their supply chains, we are seeing, companies looking at Japan as a market that could benefit from this. We know there are very large companies which are signing contracts to build manufacturing plants and large R&D centers in Japan. There are also domestic companies that are doing the same. And while this is going to take a long time to play out, we believe because of its political stability that Japan is one of those countries along with some of the other multi-aligned countries that are set to benefit from this rewiring of supply chains globally.
Oscar Pulido: And you made the case that Japan is a more diversified stock market maybe than some of its developed market peers. I think you talked about the US and the peers in Asia as well, having more of a tech concentration. So, talk a little bit more about Japanese companies and. Businesses, what is it that makes them unique for investors to consider?
Belinda Boa: There’s so many unique stories that are really playing out now, some of those opportunities actually are driven off the headwinds which Japan has faced over the last couple of decades. Japan has had a declining workforce since the middle of the nineties, and that’s because of its aging population. It actually leads the world in a graying population- they call it a silvering population. And as a result, it has actually been focused on developing, medical technologies and factory automation to deal with the fact that they’re going to need to address labor shortages. As a result, there’s some global companies, which are leaders right now in this space, not only to provide those type of services and factories as needed in Japan, but also globally.
An example of that would actually be railway operators. They’re using AI to monitor remotely and to improve the efficiency of the railways. This is an area which is growing, not just domestically in Japan, but also there is a need for this globally because Japan is now not just unique in an aging population with a tight labor market and labor shortages.
Medical services and products is another area where we are seeing Japan has been focused. Also because of its aging population, but there is now a regulation which is coming through. So as of April, doctor’s hours are going to be regulated in Japan. The need to have medical services and products which will be able to alleviate the hard-working hours of doctors, is now a regulatory requirement. So, we are seeing investing in this infrastructure. And we think that there’s going to be a global need for this, so again, we are seeing the need of some of these unique investments that Japan has made over the last couple of decades now playing out in both innovation and leadership for aging populations.
Oscar Pulido: So, Belinda, when you went back through the timeline of Japan over the last few decades, you touched on some economic reforms that started about 10 years ago. They were called Abenomics, and this was when Prime Minister Shinzo Abe, introduced economic reforms, and I think they didn’t quite deliver the impact that they were intended to. You’ve touched on some more targeted, regulatory reforms in your comments around healthcare, savings schemes that individual investors have, but usually at a country level, there are some more significant reforms that need to take place for a country to really experience this revival. So, can you talk a little bit more about those?
Belinda Boa: Yeah, corporate transformation, so this is a unique story to Japan. It’s one of the biggest themes that we have had in our portfolios over the last year and a half. Japan used to have a significant number of conglomerates. Or complex organizations with a number of listed subsidiaries. They were both difficult to analyze, but also a lot of these were not profitable or had very low growth prospects. When Abenomics introduced, the third era was very specifically directed at this corporate reform. We have seen a number of companies restructuring, and spinoffs of non-core business. And that’s actually generated, improved multiples for the companies, higher profits, and clearly the equity prices have reacted as well. This is just the start of this transformation. There are many more companies that are going through that right now. So, we do believe that there is still a huge amount of embedded value that can be unlocked from these corporate transformations going forward.
But look, it’s not only the government policies like Abenomics, which have helped with this corporate transformation story. We’ve also seen the Tokyo Stock Exchange, which has called for better capital efficiency of companies. And by that, they are focused on making sure that companies, stop hoarding their cash and spend their time looking at how to spend it and how to improve shareholder returns. So, it’s focused at the end of the market where book value companies are low. That was a reform that was actually introduced in 2023. As of a couple of days ago, the Tokyo Stock Exchange has taken it one step further and they have decided they’re going to name and shame companies that fail to report on how they’re going to release value for shareholders and how they’re going to improve their book values. That has actually been one of the most significant themes that we’ve been invested in over the last number of years, and it’s playing out. And while I think there has been progress, we’re seeing change in multiples, we’re seeing business models improve.
There’s still a long way to go, Oscar, when I look today at the Top Ex, which is the broad index in Japan, roughly half of the companies still trade below their book value. And what that means is they trade below the value of their assets. So, there’s still a lot of upsides here, in terms of corporate transformation, it’s one of the bigger opportunities and themes we’ve been invested in.
Oscar Pulido: And it sounds like what you’re describing takes some time to play out. It doesn’t happen in a week or a month or maybe even a year but makes this an interesting market then to follow for the next couple of years as things like what the Tokyo Stock Exchange is doing come to fruition. And you mentioned where you’re sitting, we should mention that you’re recording this, in Singapore at a rather, late hour of the evening to accommodate us. But you’re the head of active investments in the Asia Pacific region for BlackRock. So how do you think about the role of an active investor when you’re looking at the Japanese market?
Belinda Boa: It’s a good question, I feel biased answering it, but let’s be clear. We believe that Japan is going to have a larger role in global portfolios because of all the things that I’ve mentioned going forward. And whether that is a role in terms of just broad index exposure or whether it’s an active exposure, so relative to a benchmark, or even a private exposure. I just believe that because of this transformational story that is playing out, we are going to see more interest and more investment in Japan as a whole.
However, because of this massive transformation that we are talking about, and because Japan is ripe for stock picking, Tokyo Stock Exchange had 3,900 companies listed on the exchange at the end of December. It is deep, it is liquid. As I’ve mentioned because of this transformational story, not all companies are ripe for the changing business model environment and are going to benefit from some of these things. So, I’d argue that this is one of the few markets where you really do want to be active, so that you can be on the right side of that trade if you want to enhance your returns in Japanese equities.
Oscar Pulido: Right, it’s a large market with a lot to choose from and perhaps some inefficiencies that are going to start to correct themselves in the years ahead. So, an active investor has a good playground from which to choose from. Belinda, you’re probably familiar with the five mega forces that the BlackRock Investment Institute has put out, and we’ve talked about them on the podcast.
You’ve actually mentioned a few of them in your comments. You talked about artificial intelligence, aging populations, and geopolitical fragmentation. Other mega forces include the future of finance, and the low carbon transition, as you think about. Japan, what are some of the most compelling mega forces that you think impact that country?
Belinda Boa: Yeah, the one I probably haven’t spoken about is this transition to low carbon. It is front and center for Japan, and interestingly, it has been probably long before sustainability, the term became popular globally. And the reason for that is Japan has had to focus on the scarcity of natural resources, and its social values given the changes that I’ve mentioned from demographic perspective. It is a country that has faced unbelievable earthquakes and tragic tsunamis over the years, and there is a deeply felt duty to both protect and preserve the environment in Japan. That combined with the country’s expertise in engineering and innovation has meant that it’s actually developed energy efficient industries years before the rest of the world was starting to look at that. It was the first place that developed the hybrid electric vehicle. It also has this deep sense of renewables, and in fact, plastic bottle recycling, it has been running at over 80% in Japan for over the last decade. That is significantly lower in other countries, so just examples of how focused the country has been in terms of the theme around sustainability.
But more important than anything else is the fact that we are seeing both public and private companies aligning with the government’s commitment of 150 trillion yen to building a sustainable future in Japan. And that means we’re going to see more leadership and more innovation from companies around the theme of sustainability coming out of Japan. And they will thrive in that environment.
Oscar Pulido: So, it sounds like almost all of the mega forces are somehow interweaving in the Japanese investment opportunity based on what you’re saying. Belinda, I know that you’re actually from South Africa. you spent part of your career there, you’ve worked in London, you’ve worked in Hong Kong, now you’re in Singapore, you have this great global perspective. I’m just curious, when you go and visit Japan, is there anything that, jumps out at you in terms of the economy, the industries, the companies that you’re looking at that you’d want to share some perspective.
Belinda Boa: I’ve traveled to Japan for years, Oscar actually one of my first trips to Japan, I wouldn’t have even considered going to Hong Kong or Singapore as Japan was really the hub. It was the hub of Asia, that’s, where business was done for Asia. I remember one of my first couple of trips to Japan, I needed someone to walk me through the station because there was no way that I could navigate the station, it had no English language. I’m sure you know that from your trips as well. But one of my more recent trips to Japan, I stood in a queue at immigration for an hour and a half. And that is not speaking about any inefficiencies in immigration in Japan, it really was speaking to the number of tourists that were coming into Japan. It has become an absolute global destination for tourism. Certainly, in Asia, if you speak to anybody, their number one choice of destination is Japan. and Japan, when you look at the numbers, is seeing a real boom post covid in terms of tourism. That’s true because it’s a fantastic cultural hub, it’s a shopping hub, it’s got beaches, it’s got magnificent skiing and not to mention all of the incredible food.
I mention that because for a lot of our investors globally who have not seen and felt on the ground the transformational story that I’m talking about, it is an incredible destination to go to. And lastly, it is now 35% cheaper than it was a year ago because of the yen depreciation, I think tourism’s going to continue to boom. It’s an open politically stable economy in our part of the world, which is, looking for the story of transformation and as it plays out, I think getting a feel for it on the ground is going to be super important.
Oscar Pulido: You’re right! I have had that experience of walking through the train station and feeling a bit lost, fortunately, I was guided by somebody. But it gave me the sense that there’s a lot about Japan that I don’t know, and you’ve helped fill in some of those blanks today. Belinda, thank you so much for your views on Japan, and thank you for joining us on The Bid.
Belinda Boa: Thanks Oscar!
Oscar Pulido: Thanks for listening to this episode of The Bid. On our next episode, I welcome Catherine Cress, head of geopolitical research and strategy at BlackRock to discuss what the economy can expect this year from the world of geopolitics.
Sources:
FactSet and MSCI (for current %); for 1989 %, 14 Fascinating Facts About Japanese Stocks — From 1989 | The Motley Fool;
History of Financial Crises, JAPAN’S LOST DECADE, September 29, 2021;
Japanese Inflation Rates: 1971 to 2024
Refinitiv Datastream, Japan Ministry of Internal Affairs and Communications, Reuters, BlackRock. Data as of Oct. 2023.Bloomberg. Data as of Sept. 2023.
Reuters ‘Explainer: What is the Tokyo Exchange’s new list of firms disclosing capital efficiency plans?’ January 15, 2024
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