LAND OF THE RISING SUN: A NEW DAWN FOR JAPAN?
Why Japan is back in the spotlight.
2023 may well come to be remembered as the year of peak artificial intelligence hype. However, there is another notable development underway, one that’s less prominent but arguably even more significant for investors: Japan is recovering from its interminable slump. Indeed, a whole 34 years after Japan’s equity bubble burst, its benchmark equity index Nikkei 225 has come close to recovering its losses. This is nothing short of extraordinary, given that Japan’s economy went through the longest, most profound, and most painful boom & bust in modern history. In the 1980s, Japan’s economic model was widely expected to be taking over the world.
The Nikkei 225 exemplified this belief, shooting up from approximately 6,500 points in early 1980 to over 37,500 at the end of 1989. However, barely two years later, it had more than halved, falling below 15,000. It spent the following years doing poorly, touching lows under 8,000 by 2003. In other words, the Japanese stock market rose almost six-fold in the 1980s, only to lose nearly 80% of its value in the 1990s and early 2000s.
One lost decade followed by another
To make things worse, there was no V-shaped recovery. To the contrary, even 22 years after its peak, the Nikkei was stillworth just little more than one-quarter of its former value. Japan’s & quot; lost decade" of the 1990s, as it was called, turned into two lost decades. It took until 2013, i.e., 23 years from the bursting of the bubble, for a modest recovery to set. in. After countless false starts, Japanese equities quietly started rebounding almost exactly. Ten years ago. Since then, the Nikkei has more than tripled to over 32,000 points, back to the level of 1990 and not far, in the scheme of things, from its all-time peak.
Where did it all go right?
What did suddenly change? We believe that, originally, the main driver has been better corporate governance. Historically, shareholder value and shareholder rights have been pretty much non existing in Japan. This didn’t bother investors in the 1980s, as they had come to believe that Japan’s economic model somehow didn’t need governance to function, but it started to be recognised as a profound structural weakness as soon as the economic bubble deflated.
It took decades to reform the relationship between Japanese companies and shareholders. from within, after external attempts to do so failed, but at long last things have changed for the better. As a result, it is fair to say that the country’s corporate accountability to investors has never been as good as it is today.
Japan is the new China
Another more recent driver of the equity market has been a push to diversify away from China. For many years, China monopolised foreign investment into Asia thanks to its staggering growth rates. However, over the course of the 2010s, as economic growth started slowing down and concerns about Chinese corporate governance increased, a gradual shift away from China took place, and Japan reaped some of the benefits.
“Suddenly, the same investors who ignored Japan’s shortcomings in the 1980s started to see
similarities with China's shortcomings in the 2020s.”
Finally, over the last few years, everything that went wrong for China has seemed to go right for Japan. First, there were the trade disputes with the US that began in 2016, which made Chinese supply chains more expensive and less predictable than ever before. Then these trade disputes escalated into conflicts about intellectual property, followed by the economic paralysis of China’s Covid policies, from which the country still hasn’t recovered to this day.
Suddenly, the same investors who were so blind to the shortcomings of Japan’s economic model in the 1980s started to notice the shortcomings of China in the 2020s, finding plenty of similarities between the two that they wished they hadn’t seen. Last but not least, geopolitical risks around China have skyrocketed, for obvious reasons, which directly benefits Japan as a bulwark of peace, stability and the rule of law ever since the end of the Second World War.
Nowadays, even investors who want to keep an exposure to China are looking for ways to do so indirectly to avoid the risks of direct investments in what is an increasingly unpredictable country, and Japanese companies offer plenty of opportunities to do so. In other words, following three decades where Japan was considered to be un-investable, it is now China that’s looking increasingly un-investable, and Japan is an attractive alternative.
Japan: the pros...
What does Japan represent in the world today? It is the fourth-largest economy and the third-largest stock market in the world, with leading globally established companies in key sectors and attractive valuations compared to American and European peers. These facts alone prompt many investors looking for exposure to Asia to consider Japan once again as a natural place where to invest.
...and the cons
On the other hand, the country suffers from long-term demographic decline. To give an idea of its magnitude, in 1990 the population’s median age was approximately 35 years. Today, it is nearly 50, and it will easily exceed this number by the end of this decade. The chart below illustrates the demographic time bomb in its two manifestations: the ageing of the population and its fall in numbers. Both are toxic for economic growth.
It is true that a similar trend is underway in the rest of the developed world, too, and even in some hitherto fast-growing countries such as China. But that does not make Japan’s demographic decline any better. If only for this reason, the country can’t possibly return to the heady growth of the 1980s.
Heading for a normalization?
However, that is not the point. The point is rather that, after a decade-long boom in the 1980s and a two-decade-long bust thereafter, the country may well be settling somewhere in the middle, that is to say, become “normal” again. If this is the case, the stock market’s recent rise appears to be justified. For investors this is exciting news, because it means that a huge market opens up again, offering a welcome alternative to European and US markets.