Op-ed in the Financial Times: Japanese Stocks are Well Placed to Confound the Sceptics

The following op-ed by Kathy Matsui, Vice-Chair of Goldman Sachs Japan, appeared in the February 12, 2020 edition of the Financial Times.

Japanese Stocks are Well Placed to Confound the Sceptics
By Kathy Matsui

Japanese equities have been shunned for some time. The country was picked as the least preferred region among attendees at our global conferences last month. That was not surprising given Japan’s underperformance last year, because of headwinds including trade conflict and disappointing corporate earnings. But there are a few reasons to think this view is overly pessimistic.

The immediate concern among investors is the coronavirus outbreak. But we estimate that even in a scenario where the rate of new infections did not peak until the second quarter, the negative hit to global economic growth would be about 0.3 percentage points. That means the expansion would still be 3.1 per cent — in line with last year’s pace.

For Japan, tourism is one of the most directly affected areas, but since inbound consumption represents just 0.8 per cent of the economy, the overall hit to growth is likely to be limited.

Many overseas investors have lacked conviction in Japan’s profit recovery, with the combination of trade friction and weaker global demand triggering sizeable downgrades to company earnings last year. However, those revisions are bottoming out and even turning positive. If a more severe coronavirus scenario is averted and global growth reaccelerates later this year, Japanese equities are well positioned given their heavy exposure to cyclical sectors such as technology and machinery.

Japan’s domestic demand — which accounts for roughly three-quarters of economic growth — is also likely to remain resilient. An extremely tight job market and new legal caps on overtime should help improve incomes. The economy will receive an additional boost through capital spending by the private sector, which is striving to enhance productivity, and by the government, which is directing the bulk of a $240bn fiscal package to fortifying public infrastructure against natural disasters.

Even assuming the yen averages ¥105 against the dollar, earnings per share for Japan’s companies should rebound 8 per cent this year and another 6 per cent in 2021 — higher than our forecasts for the US S&P 500 index of 6 per cent and 5 per cent, respectively.

And given that 45 per cent of Tokyo Stock Exchange companies are trading below book value — against 6 per cent for the S&P 500 and 16 per cent of Europe’s Stoxx 600 benchmark — we see scope for the market to recover. The Topix and Nikkei 225 indices should rebound to 1,800 and 25,000 respectively by year-end.

Finally, there is widespread scepticism that progress made in the area of corporate governance in Japan will continue. The implementation of tighter foreign direct investment regulations has triggered concerns that these new rules, nominally aimed at protecting national security, will instead restrict activist investors.

The ministry of finance has tried to allay those fears. It has just completed an international roadshow aiming to clarify the new rules and has stated repeatedly that it has no intention of hindering corporate governance progress, nor investor-investee engagement.

Investors should be reassured by recent trends in corporate activity. For instance, shareholder returns — buybacks and dividends — reached a record high of ¥16tn last year. We forecast a further 29 per cent increase by next year. Investors are no longer silent, with the number of shareholder proposals more than doubling over the five years to 2019.

Takeover bids have also been surging, reaching a 12-year high of ¥2.1tn in 2019, with the average size of takeover bids rising to a record ¥49bn. This has been fuelled by growing pressure on management teams to restructure their businesses and heightened scrutiny on the Japanese phenomenon of listed subsidiaries.

Furthermore, there is a nascent but growing trend of hostile takeovers. Last month Maeda Corporation, a construction group, launched an unsolicited bid for Maeda Road Construction. An investment fund backed by activist Yoshiaki Murakami announced a hostile bid for Toshiba Machine in January.

Last year also saw the number of companies scrapping so-called poison pills — measures taken to fend off hostile takeovers — exceed the number of groups adopting them. In order to protect themselves from being taken over, the only effective solution is for management teams to work to push up their share prices.

There is certainly room for a revaluation of Japanese equities. Since the start of Abenomics in 2012, Tokyo’s Topix index has more than doubled. These gains were driven by profit growth, with the forward price/earnings multiple actually contracting from 18 times to 14 times. Compare that with US and European equities, where performance has been lifted by a combination of earnings growth and higher valuations, with PE multiples of 18 times and 15 times, respectively.

With better cyclical tailwinds and further progress on corporate restructuring, this trapped value may be released faster than the market expects. Global investors who are underweight Japan may face motazaru risk this year — the risk of not owning enough.


This article originally appeared in the Financial Times on 12 February 2020.