Japan Equities – Lukas Knueppel

What were the major recent events and what were the impacts on your asset class?

The Japanese stock market achieved a 33-year high in the second quarter. One of the main drivers was a better than expected earnings season with net profits growing by 13% versus last year excluding SoftBank. We also saw a record number of share buybacks announcements, which leads us to another important supporting factor: the corporate governance reforms requested by the Tokyo Stock Exchange for listed firms in Japan to improve their capital efficiency. At the same time interest rates in the US weakened significantly which led the yen to weaken due to the growing gap between the Bank of Japan’s (BoJ) easy monetary policy and the hawkish stance of peers such as the Federal Reserve and the European Central Bank (ECB). Throughout the quarter index performance was primarily influenced by the largest index weights while the Topix Core 30 index outperformed the Topix Small index by nearly twice the margin. And finally, in terms of investment styles, there was a clear preference for value stocks over growth stocks.

What can your asset class offer in the current environment?

The initiative by the Tokyo Stock Exchange that was announced in April for Japanese listed companies to work on their capital allocation is significant and unique at the same time. While the Tokyo Stock Exchange has been pushing for corporate governance reforms for a long time, its most recent efforts addressed the poor capital allocation decisions at numerous firms which have led to low price to book valuations in Japan. We saw first evidence that some listed firms in Japan started to critically examine their capital allocation strategies and we expect more firms to increasingly return excess cash to shareholders through dividends and share buybacks, which should result in an increase in return on equity and likely raise corporate valuations. We believe this represents a unique opportunity that does not exist as such in other regions and which could be a solid supportive driver for positive returns in Japan in the next years to come.

What’s your outlook in the near and medium term?

The most recent Tankan Manufacturing Survey showed that sentiment among large Japanese manufacturers has improved for the first time since 2021 on the back of falling raw material prices and strong capex investment plans for Japanese corporates. For the second half of 2023 we expect the recovery in order momentum in the manufacturing sector, led by the semiconductor industry, after inventories will have adjusted in many sectors following the stabilisation in global supply chains in the aftermath of the pandemic. Consumption is supported by the strongest pay rises in decades in Japan and a boom in tourism with more visitors arriving to Japan from increasingly wealthy Asian neighbouring countries. All in all we expect corporate profit growth in Japan to re-accelerate towards the end of the year and grow well again in 2024 supported also by lower input prices and lower freight costs.