Open for Business

In June, I had the opportunity to return to Japan for the first time since the global pandemic began.

As well assessing the general feel ‘on the ground’, the purpose of my visit was to research and meet with companies that had the potential to emerge from pandemic stronger than their pre-COVID positions. This placed the focus on domestic companies that had initially suffered from the dip in tourism but had managed to offset those losses by diversifying their strategy.

Flying into Japan, my expectations of what life might look like post-pandemic were low. It’s no secret that the country has been slow to re-open in the wake of COVID-19, and any radical change seemed unlikely. However, on arrival, I found it was very much business as usual on the ground, with little change from my previous visits. In Tokyo and other cities the streets were bustling and full of life, while offices appeared to be mostly populated. The only difference from my previous visits were face masks, which were worn by all.

This sense of normalcy appeared due, on a relative basis, to the stability of Japan’s political and macroeconomic situations, the latter of which, despite being relatively low growth, has left Japan somewhat insulated from the rise in global inflation. This is perhaps the legacy that of Shinzo Abe, the late former prime minister. Abe was Japan’s longest-serving leader and through his economic reforms, known as ‘Abenomics’, the country has become a bastion of stability. This stability showed itself in summer in terms of how the country responded to the BA5 variant of coronavirus that was beginning to spread across Japan. There was no state of emergency issued by the Japanese government or local authorities. This sense of calm allowed Japan to quietly adapt and continue with little disruption.

Navigating the pandemic

The reopening of the economy after the pandemic has been conservatively paced, with borders having only fully reopened in October. Tourism and foreign spending appear to be coming largely from visitors from Hong Kong and mainland China. Both Hong Kong and mainland China have quarantine policies in place for returning travellers so tourism is likely to bloom slower than one might hope. But it is nevertheless an encouraging sign that normality is resuming.

A big beneficiary will be the hotel and leisure industry (amusement centres, in particular), where the utilisation and Revenue Per Available Room (RevPAR) rates stand to gain from increased tourism. This area had already begun to tick up during the summer months.

There are other areas and sectors which have suffered from a dip in footfall during the past several years. For example, the railways in Japan have seen significant declines in the number of passengers using their services. Tourism and increased international business will likely spark a revival in passenger numbers, the prospect of which may be an investment opportunity for areas such as airports and airlines.

More broadly, tightness in Japan’s labour market presents an indirect way to play the reopening trade, with staffing and services set to benefit. Over the past decade, Japan has been able to offset the decline in the working population (due to unfavourable age demographics) by two primary methods. The first has been a rise in the female labour participation rate, which stands well above the Organisation for Economic Co-operation and Development (OECD) average. The second factor was workers over the age of 65 either re-entering or continuing to work. Both of these resources are now appearing stretched and recruiting from overseas won’t be easy either. The weakened value of the Japanese yen in relation to the U.S. dollar will likely deter international workers from selecting Japan.

With the above in mind, we see great opportunities in sub-sectors such as recruitment and staffing, as well as IT, which are positioned well to cover the gap in labour participation.

Challenges and opportunities

During the first half of the year, we witnessed an aggressive style shift from growth to value which was certainly of detriment to the more technology-oriented stocks that one associates with Japan. This shift has since begun to stabilize but we remain some way off the optimum environment for growth stocks.

More broadly, we are still facing a slowly decelerating macro economy and we, as investors, will need to dig deeper to unearth companies that can achieve higher growth than the market. This will require us to be nimbler as we consider the valuations that companies are trading at, with many outperforming growth names currently priced highly and therefore limiting the upside potential for investors.

In this regard, the value of in-person meetings is immense and offers the prospect of a more qualitative assessment of a company, its culture, and its environment – all factors which are crucial when considering an investment decision.

Over the longer term, global trade winds may start to blow in Japan’s favour. Over the past 20 years, globalisation has been a one-way street with manufacturing largely been routed towards China as the world’s most efficient supplier. But now, following the pandemic and the inflationary events of 2022, as well as ongoing geo-political tensions between China and the west, we have observed a modest reversal of this trend. Some nations are seeking to bring manufacturing ‘in-house’, or at the very least, diversify their sources. This may work to Japan’s benefit, with its rich tapestry of technology providers likely to be well-placed to support this shift over the longer term as nations build factories and begin generating more of their own products. It should be noted that in the near term, company profitability may be impacted due to the diversification of manufacturing sources.

In summary, the reopening trade will be a key support for Japanese equities, and it has some way to run with Japan’s borders having fully opened a little over a month ago. Domestic opportunities are significant, with pockets of depressed sectors poised to benefit. Within this, we believe that the key component for Japanese equity investments will be companies that have a strong market share or positioning in areas of growth and labour shortage. Such companies will have plenty of room to stretch their legs and may provide enticing long-term investment opportunities.

We are upbeat about Japan’s potential over the coming months, a notion that was only emboldened by my visit. And I look forward to finding out more—and reporting back—from my next trip. There are headwinds. The yen in particular is a challenge and a benefit. But by being slow to reopen, the Japanese economy has remained stable, if unspectacular, and in my view is now poised to offer value to international investors as normalcy resumes.

Shuntaro Takeuchi
Portfolio Manager
Matthews Asia

Takeaways

Business as usual - Japan remains stable and productive, despite geopolitical headwinds.

Reopening trade has room to run - Having recently reopened, there are plenty of depressed markets poised to benefit.

Labour tightening is key - Japan’s ‘people shortage’ will put pressure on labour markets and offer opportunities for providers.

An environment for solutions - Demographics remains an issue, but solutions providers may prosper.

Appeasing the globalisation shift - International shifts away from China present opportunities for Japanese tech providers.