Entry level (valuation and exchange rates)
The Japanese equities market gained 28% in 2023, while the S&P 500 had appreciated by 24%. However, the outlook remains positive. Japanese companies' multiples are at a 20-year low.
29/02/2024
Japanese equities
Improved returns at Japanese companies
-
+7,5%
Improvement in Japanese companies' returns (ROE) in the last two decades
Source: Bloomberg as of 19/02/2024 (MSCI Japan index). -
42%
Enterprise valuation multiple (EV/EBITDA) at a 20-year low (down 42% in the period)
Source: Bloomberg as of 19/02/2024 (MSCI Japan index). -
30%
Depreciation of the Japanese yen since January 2022
Source: Bloomberg from 01/01/2022 to 19/02/2024.
Japanese companies have improved how they manage funding over the last 20 years. The below chart shows that, in terms of ROE, Japanese companies have outstripped US and European companies in that period. This growth has been driven mainly by the modernisationof business management approaches in Japan.
One example of this modernisation of management is the greater efficiency in managing funding. Previously, Japanese companies tended to have almost no debt and considerable liquidity (sometimes more than 50% of the balance sheet), which had a negative impact on ROE. However, their performance has been positive since 2003, with the return on equity (ROE) growing by 7.5%.
Japan's Corporate Governance
Japan's Corporate Governance Code was drafted by a committee of experts in August 2014 based on the G20/OECD Principles of Corporate Governance2; it is reviewed every three years. This code was introduced in order to enhance companies' transparency, efficiency and risk management. The main goals of the code are:
- Generate growth at companies by fostering transparency.
- Support sustainable growth by companies.
- Modernisegovernance and the capabilities of management bodies.
- Promote investment by Japanese retail investors.
Another factor that might help boost the valuation of Japanese enterprises is the change in domestic demand for equities. Historically, Japanese retail investors had almost half of their wealth in cash or bank deposits. To reduce this gap, the government introduced tax exemptions as an incentive to purchase equities. In 2014, it introduced a 20% exemption in the tax on capital gains and dividends for investments of JPY 1.2mn per year for a maximum period of 5 years; however, from 2024 onwards this exemption will be doubled and apply indefinitely. This reduces the incentive to invest in overseas equities.
Why invest in Japanese equities?
Depreciation of the yen might benefit investments in local currency
If the BOJ eventually decides to raise rates, Japanese investors could repatriate some assets to Japan, which would cause the yen to appreciate. At present, the exchange rate is around JPY 150 to the USD1(-30% since the end of 2021). To put that into context, it is a 30-year high.
Macro outlook: Moderate inflation
In the last few years, inflation in Japan has typically been very low, and occasionally negative (deflation). This contrasts with the 2% target adopted by most developed countries' central banks.
However, the cultural shift taking place at companies is also reflected in workers demanding higher wages, which could push inflation higher.
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