Necessarily Surprising and Sufficiently Important
The Bank of Japan's unexpected decision to raise it's Yield Curve Control (YCC) ceiling is important. So important that investors are excited.
Whilst necessarily surprising, the Bank of Japan's unexpected decision to raise it's Yield Curve Control (YCC) ceiling is also sufficiently important. In fact, so important that investment managers globally are getting excited about the prospect of a new dawn for Japanese equities and bonds.
But before this excitement spills over into new investor allocations, the question is whether the BoJ allowing 10 year Japanese Government Bonds (JGB's) to trade in an increased range (up from +/25bps to +/-50bps) versus 0%, is actually a catalytic call to action.
Japan has been fighting deflation for decades. Today the current benchmark rate is set at -0.1% despite inflation hitting a multi decade high in November at 3.8%, well above the BoJ 2% policy target. Yet Japan has also been one of the few countries globally not to have tightened monetary policy in 2022. It should also be noted that Japan is also one of the few countries globally with a Debt/GDP ratio above 200%, of which approximately half is owned by the Bank of Japan.
Put differently, any decision by the BoJ to meaningfully tighten monetary policy at this stage may have less desirable side effects. Neither Governor Kuroda, nor his successor in April 2023, wish to be responsible for extinguishing these early inflationary sparks that could alight a long awaited cytlce of wage inflation, higher consumer expenditure and capex growth.
Nevertheless, as a signal, the widening of the Yield Curve Control ceiling has investment managers and institutional investors seeing amber. Which means they may be changing up a gear in 2023 when it comes to Japanese assets.
Lots To Be Positive About
Japanese Equities are re-capturing the attention of institutional investors. There are many factors that support the renewed enthusiasm.
Raising assets for Japanese Equities over the past decades has required patience and persistence.Most institutional investors simply follow but do not over-commit to the market. That may be changing. Across the Japanese Equity manager research, four tangible justifications for serious reconsideration are being hammered home: Relative Equity Valuations, Yen Outlook, Inflationary Outlook, and measurable improvements in Corporate Governance and shareholder returns - as supported the recent increase in share buybacks. Japanese Equity research is currently being eagerly read.
Quite simply...yes. And with reason.
The BOJ’s resistance to tighter policy and higher JGB yields is understandable, but this is not a sustainable situation. Within equities, the impact of a weak yen varies from sector to sector. The BOJ is facing two bad choices: continue to allow the yen to weaken, sapping purchasing power; or, raise rates, likely leading to a drag on economic activity.
ON INVESTORS MINDS
Japanese Equities are gaining momentum with investors. The universe includes global leading companies with strong balance sheets not found elsewhere.
The case for Japanese Equities is showing signs of improvement that is bringing professional investors back to the discussion table with investment managers. There are many things to be positive about.
Read the latest portfolio manager views on Japanese Equities inside RFPnetworks.
Positive News Keeps Coming
Japanese Equities have struggled for decades. But the major investor concerns are being addressed and the market is gaining popularity for good reasons.
The case for Japanese Equities is showing signs of improvement that is bringing professional investors back to the discussion table with investment managers. There are many things to be positive about:
Corporate reform momentum has been continuous, having been kick-started by Shinzo Abe and carried forward by Prime Minister Fumio Kishida.
Almost half of Japanese Companies have on average 20% of their equity value in cash.
On an absolute basis, Japan has delivered lower returns than other developed markets over the past decade. However, digging deeper, these returns have been driven by earnings and dividends, and not by P/E multiple expansion, as in the US, Europe and the UK. Since 2013, dividends for the Tokyo Stock exchange have doubled.
And there's more to be positive about in Japan:
Inflation is back - 12m Headline Japanese CPI rose to 2.5% at the end of April 2022, compared to an average of 0.3% over the previous 30 years. In itself a milestone that has the potential to shake up the dormant status quo.
Wages may be on the rise - Japanese companies had given up trying to raise prices against an inelastic consumer, which in turn removed the need for employees to demand wage increases to counter the cost-of-living increases. In many respects companies may be to blame for their inability to raise profits at home. Corporate Japan encapsulates a job-for-life environment and mechanical pay increases linked to promotion, not performance.
But with Prime Minister Kishida's now providing tax incentives to raise wages, and the Bank of Japan's 'downgrading' of it's perception of price risks from 'skewed to the downside' to 'balanced', the non-consequentialist view of inflation in Japan could change. Or at least with the younger demographic.
Nippon Individual Saving Accounts (NISA)
In March 2022, net inflows into tax deferred accumulation investment plans increased by 20%. Early signs that young people are leaving the 'zero-inflation' mindset camp.
Collectively, the continuance of domestic policies to increase, wages, productivity and equity participation, seems to be yielding shoots of success. Which in turn has professional investors reconsidering raising allocations.
Data Supports A Comeback
Japanese Equities may be coming back into investors portfolios. Share buybacks are rising and corporate governance is improving at world class companies.
Japanese Equities are often on the back burner of Professional Investors Portfolios. With each new leadership change over-promising and under-delivering on fundamental challenges that cause continual concern. But is that changing? Several datapoints would suggest it is:
Over the past 12 months, share buybacks have increased by almost 70% versus the previous year. Suggesting management have renewed confidence in their company's fundamentals. A good sign for shareholders.
A second, more persistent problem in corporate Japan has been Corporate Governance. But with revisions to the Japanese Corporate Governance Code enacted in June 2021, attention to diversity and Task Force on Climate-Related Financial Disclosures for Prime Market listed companies is gathering tangible momentum.
Then there is the divergent macro backdrop and valuations. With the Bank of Japan (BOJ) maintaining its negative policy rate and yield curve control purchases - despite peak inflation forecasts of 2% for 2022 - the Yen is trading at its lowest level versus the USD in 20 years. Which in turn creates a competitive pricing export edge for its world class auto and robotics companies. Lots to be positive about for investors.
Inversion and The Yen
Japanese equities are theoretically impacted by the influence of the US Yield Curve on the Yen. But the Bank of Japan knows this and may react accordingly.
Whilst the U.S. economy has not entered into recession yet, some strategists are arguing that the presence of an inverted yield curve can slowly induce an economic and stock price downturn.
But how will other markets react, and in particular Japanese equities?
Looking at past episodes of an inverted US Yield curve, the answer is not clear. With the impact on several core Japanese sectors - electric appliances, precision instruments, machinery, pharmaceuticals, automobiles & transportation equipment - being highly dependent on whether the Japanese Yen appreciates or depreciates. Which in turn is a function of the interest rate differential between the U.S. and Japan, and how the Bank Of Japan reacts.
ONE TO WATCH
Japanese Technology companies are gaining the attention of investors looking to transition portfolios to Net Zero Emissions (NZE).
Japan's economy and companies are not immune to commodity price inflation caused by the Russia-Ukraine crisis. However, the world's renewed focus on energy autonomy and net zero emissions (NZE) may boost the demand for energy-related and decarbonisation technologies, made in Japan.
Read the latest views from ESG and Japanese Equity investment managers inside RFPnetworks.
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