Three Minutes on Japan

As I gauge the outlook for Japan’s equity markets and reflect on their recent impressive performance it’s clear to me that there are a multitude of forces at work.

Firstly, Japan’s markets have benefited from multiple expansion over the last 18 months. Domestic investors have flooded the market encouraged by the capital reforms that corporates have made which have yielded significant benefits for shareholders largely in the form of increased stock buybacks and dividends.

It’s worth noting that even with a record high of share buybacks by Japanese corporates last year, that total amount was still less than the value of Apple’s 2023 buybacks. On top of that, about half of Japanese listed companies are net cash. So we think the potential for enhanced returns from buybacks and dividends will remain a force for a while though to greater and lesser degrees across sectors and industries.

Secondly, Japan has earnings growth momentum. This is important because over the past 10 years the majority of shareholder returns have come from EPS growth and resulted in Japan being the best performing market by U.S. dollar returns, with the exception of India, among popular equity allocations outside of the U.S.¹ Japan’s earnings growth isn’t closely connected to its GDP growth, which compares poorly with other developed markets. Instead, the financial health of Japan’s corporates is more directly tied to exports, world trade and the global economy. We think Japanese corporates are generally in good shape and the yen’s ongoing weakness to the dollar is also a macro tailwind for earnings. 

Earnings Growth Momentum

From some of our recent company visits, a couple of other things are also clear. One is that inbound tourists are coming back, and in full. Tourism-related spending has surpassed the all-time high set before the pandemic and that’s without the full recovery of spending by Chinese tourists who represent the largest component. We also sense that while there’s increasing interest in Japan from global investors they are still very much under-invested in the market. So that has a long runway.

Looking ahead, we remain positive on Japan’s markets and we see the drivers that have strengthened in recent months staying strong. We would also highlight the long-term potential of Japanese small caps. The Nikkei 225, which consists of larger cap companies, has traded at 10-year highs in terms of valuation this year while broader Japan indexes which include mid-cap to small cap companies have traded around 10-year median averages.² So we believe there is a lot of upside in the small cap and mid-cap space.

Of course, we don’t invest in large caps or small caps for the sake of their size. We always invest in companies that have superior growth over the mid to long term.

Shuntaro Takeuchi
Portfolio Manager
Matthews Asia

¹As of May 3, 2024; ²as of May 6, 2024. Source: Bloomberg