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Is Japan Back?

30 April 2021   |  

Perhaps you missed it, but Japan’s equity market is back to levels not seen since before its 1991 crash and subsequent lost decade—arguably decades. In March, the Topix Index reached a 31-year high and has since held up relatively well despite a resurgence in COVID-19 cases, a seemingly slow start to vaccinations, renewed business restrictions, an earthquake in February and the decision to hold the Tokyo Olympics at least without fans from abroad and possibly without any at all.

Japanese Stocks Finally Recover

Source: Bloomberg. As of 28 April 2021. Past performance is not indicative of future results.

The return to such heady levels raises some important questions—namely why, what does it mean for Japan and can the good times keep on keeping on for investors? 

A strong economic rebound in the second half of 2020—at home and among key export markets such as the US—supported a similarly impressive rally in Japanese stocks. Real GDP rose at annualized rates of 22.8% and 11.7% in the third and fourth quarters, respectively. A “Zoom Boom” helped drive demand for personal technology devices, while Chinese and US vehicle sales bounced back strongly, driving Japanese exports.

The recent resurgence of COVID-19 and a global semiconductor shortage—exacerbated in Japan by an auto-chip factory fire—most likely drove the economy to contract in Q1. But there is widespread optimism for a rapid bounce back—albeit one not nearly as eye-popping as last year’s. The latest economic tea leaves largely validate the optimism. Recent labor market, export and foreign machinery orders data, as well as the Tankan large business survey have been generally favorable. Even retail sales were rebounding strongly prior to the worst of the latest COVID-19 resurgence.

Markets are also closely watching the current earnings season for the final quarter of Japan’s 2021 fiscal year. Perhaps more important than the quarterly numbers will be corporate guidance for FY 2022 and any outlooks for a post-pandemic recovery.

At the same time, some companies may feel compelled to mention corporate governance initiatives as Japan’s Financial Services Agency looks to further strengthen its corporate governance code in the areas of board independence, diversity and ESG. This comes on top of greater pressure for companies to disentangle complex cross-shareholdings arrangements—a characteristic of the country’s keiretsu system. Genuine efforts to improve corporate governance would be welcome news to investors.

An upbeat economic outlook, potential for solid earnings growth during a post-pandemic recovery and the possibility of more corporate governance progress seem like a promising recipe for further Japanese market gains. And perhaps that could be the case in the near term.

However, other challenges still seem overwhelming and bode ill for a genuine return to Japan’s glory days. Foremost is Japan’s demographics—in 2019, before COVID-19, Japan’s death rate exceeded its birthrate by more than 500,000. Genuine, material and rapid structural reforms are also needed as Japan’s productivity and position as a leader in technological advancement have been on the decline. And there is the Bank of Japan’s expansive monetary policy: Besides doing little to stimulate inflation and pull Japan out of its economic doldrums, the central bank is now the largest single owner of Japanese stocks thanks to its years of purchasing Japanese equity ETFs. The BoJ could face some significant challenges whether or not it tries to unwind its ETF purchasing program.

There is hope the pandemic could provide the shock and political cover Japan needs to make serious structural reforms. But if it doesn’t, Japan’s equity market resurgence could prove fleeting—and that would hardly be the country’s biggest problem.

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