Japan flies against global trends and in many cases, this represents an attractive attribute. Whereas high inflation, aggressive central bank policies and fears of recession loom in many parts of the world, Japan pushes back against this with low inflation, supportive central banks, a fiscally supportive government coupled with corporate reforms, cheap equity valuations and the potential for a recovery in a depressed yen.
The Bank of Japan surprised everyone with an announcement their policy of pinning the market interest rate on 10-year Japanese government bonds to a target of 0.25%, was being adjusted to allow those yields to drift higher to 0.5%. You could consider yourself justified in shrugging your shoulders and saying, “so what”, and you’d be largely right in doing so, were it not for the fact that the inactivity of the Bank of Japan over recent years, means that any movement demands an attempt to interpret the signal. In the real world there will be minimal impact (the Bank didn’t adjust anything else such as the policy rate for example), but the signal it sends, lends two possibilities.
- It buys breathing space allowing the Bank of Japan to continue its yield curve control (the name given to the policy of controlling the yield on its bonds) making it more sustainable over the long term. There are downsides, one is the amount of bonds the central bank has had to hoover up from the market to control the yield – by value, the Bank of Japan recently passed the point of holding over half of all Japanese government bonds.
- Alternatively, it sets the ground for a broader and more sweeping reassessment of these unconventional policy measures in advance of a change in the Bank of Japan Governor in April next year, easing the transition for a future Governor.
Only time will tell, but any change will lessen the downward pressure on the yen.
Improving Corporate Reform
During 2022, the Japanese stock market undertook a restructuring and governance reform into Prime, Standard and Growth sections, with Prime listed companies being the most sought after. The reforms seek to sustainably increase corporate value for shareholders, by ensuring better liquidity (and ignoring cross-shareholdings between companies in this calculation), more transparent and independent Boards and greater incorporation on ESG matters. Outside of these corporate reforms, other reforms, such as to encourage Japan’s hidden asset of highly educated women into the workplace are ongoing.
Compared to the MSCI World Index, MSCI Japan has a higher dividend and lower valuation metrics than the global peer.
Japan inevitably has hurdles to overcome. Poor demographics, high levels of debt and traditional reluctance on encouraging women into the workplace and immigration to boost its economy hinder.
Tailwinds come from an improving corporate governance framework focused on unlocking Japan’s relatively attractive valuation and improving shareholder returns, coupled with a potential currency booster if the Bank of Japan adjusts policy.