Benefiting from Japan's corporate culture amid 'bleak' macro picture
As ever, looking at Japan from a Bull/ Bear point of view proves to be a challenge.
While there are strong micro arguments to be bullish on Japanese stocks, the macro picture looks bleak and demographics continue to be a structural long-term challenge.
Additionally, while the consumption tax hike in October was somewhat cushioned by governments cashless incentive programs and other grants, when Japan was about to digest the hike, Covid-19 hit hard.
Not only were the Tokyo 2020 Olympics postponed to 2021, but global end demand and a significant disruption of the global supply chain in the manufacturing sector due to the business lock down in China, Europe and the US also pose a challenge to the core of industrial Japan.
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Domestically, transport, services and restaurants were also severely affected, a situation that could be prolonged by the 'soft' lockdown Prime Minister Shinzo Abe announced for seven prefectures, equivalent to around 45% of the economy.
Companies have yet to quantify the exact impact, but first data points such as US auto sales by Japanese manufacturers, and Japan Railways transportation data paint a pretty grim picture.
However, while data points around the world are likely to be worse than published estimates, that outcome is to a certain extent expected and therefore discounted. That could be setting the stage for bottom fishing in the months and quarters to come.
The real bull case for investing in Japanese equity sits at the individual company level. For the past two decades, there has been hope for improvements in governance and the efficacy of capital allocation by corporate management.
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Finally, we are starting to see that materialise as over the last five years there has been clear evidence of significant progress.
Corporate governance and stewardship codes were put in place in 2014-15, followed by subsequent revisions in 2017-18. Board structures have been strengthened through greater independence, committee rule and diversity.
Clear overall ESG policies have also been put in place. With internal and external pressure for higher returns growing, and companies more receptive to suggestions as to improvement in capital efficiency, the stage is set for equity market performance.
At a combined $200bn, dividends ($135bn) and share buybacks ($65bn) are running at record highs, financed out of cash flow rather than debt and in sync with ongoing investment in future growth.
The Covid-19 crisis will also ultimately shift the focus on to the strength of Japanese company balance sheets. More than 90% of corporate Japan's book value is tangible, with a significant portion in cash.
This compares to about 25% in the US - 50% of Japanese companies are net cash positive vs. 20% in the US and only 11% of companies have net gearing greater than 100%, compared to 32% in the US. Cash is king.
To best benefit from aforementioned corporate attractiveness, it is recommended to deploy an all-cap, all-style approach to stock selection. An approach that, to name a few, will see portfolios with holdings in Hitachi, Hoya and KDDI.
Needless to say, there are also plenty of attractively valued opportunities in the small- to mid-cap space.
Stefan Rheinwald is head of equity research at Waverton Investment Management
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