China and US equity markets have continued to make headlines over the past year, for better or for worse. Namely, since 30 September, US equity markets have returned 46 per cent, while China has dipped by 2 per cent.
But according to State Street Global Advisors, Japan’s superior 52 per cent returns make it deserving of increased attention.
“The outperformance of Japan compared to the rest of the world has been backed by increasing earnings forecasts, as well as price-to-earnings (P/E) expansion,” State Street Global Advisors’ Toby Warburton said.
Namely, earnings forecasts in the US have been increasing, but investors are required to pay a significant premium, in terms of valuation multiples for those earnings relative to markets such as Japan.
Meanwhile, the US’ notoriously concentrated MSCI index saw its top 10 securities deliver 83 per cent of total growth, while Japan’s top 10 names only delivered 34 per cent over that same period.
“The increased breadth in markets outside the US creates opportunities for stock pickers to generate returns; in the US, the key decision has really been about the ‘Magnificent 7’ versus the rest of the equity market,” Warburton explained.
Looking behind the curtain
Warburton asserted that his view of Japan goes beyond a “few simple ratios” and rests on structural changes, including, particularly, the corporate reforms that have driven positive changes in Japanese boardrooms and the evolution of more shareholder-friendly policies.
“The Tokyo Stock Exchange’s recent directions and intervention to improve corporate governance and capital efficiency continue to support these developments, effecting a shift in approach with corporates reinvesting their large cash reserves to fund growth,” Warburton said.
“There are tentative signs that the recent reforms are having an effect, not just on the overall market direction, but on the relative drivers of returns within the Japanese equity market.”
Notably, during the “lost decades” – Japan’s lengthy period of economic stagnation throughout the 1990s and into the 2000s – the country’s perceived “value-driven” market meant sentiment and momentum factors struggled to perform.
“With corporates hoarding large cash balances and not reinvesting, there was minimal top-line growth and earnings growth typically came from buybacks rather than increasing sales,” Warburton said.
However, since the Tokyo Stock Exchange’s most recent intervention in March 2023, there has been something of a turnaround for the momentum factor in Japan.
According to Warburton, over the past 12 months, momentum has performed significantly stronger in Japan than its long-term average while value has continued to perform very strongly.
“Over the past 12 months, the active return contribution from Japan has been the strongest individual country contributor within our global enhanced strategies,” the firm noted.
However, Warburton said that only time will tell if this is a transitory turn or a “new paradigm” on the back of the structural shifts evidenced in the Japanese market and corporates.
“For now, as active investors, we see many opportunities in turning to Japanese equities to generate not only significant alpha, but also compelling beta returns for our clients.”
Japan serves up attractive equity opportunities
A recession was declared in Japan in February after the economy contracted at an annual rate of 0.4 per cent in October to December, following a contraction of 3.3 per cent in the previous quarter, however, the stock market appears not to have been swayed.
At the time that a recession was declared, deVere Group’s chief executive, Nigel Green, explained that the main driver of Japan’s stock market resurgence lies in the robust corporate earnings reported by major companies.
“Banking, electronics, and consumer stocks, in particular, have displayed stellar financial performances, instilling confidence in investors,” Green said.
“The corporate sector’s ability to weather economic challenges and deliver strong earnings signals resilience and adaptability.”
Similarly to Warburton, Green noted foreign investors are further incentivised to dip back into Japan’s equities market thanks to the government’s implementation of “investor-friendly” regulatory reforms aimed at “streamlining procedures, reducing bureaucracy, and enhancing transparency”.
“The removal of barriers and the promotion of a business-friendly environment contribute to the positive sentiment, making Japanese stocks an increasingly appealing choice for those seeking long-term growth.”
