While the direct impact of Japan's new Reiwa imperial era on markets and the economy will be minimal, the psychological significance is important.
On May 1, 2019, the new Reiwa imperial era commenced in Japan, as emperor Naruhito officially acceded to the throne. While the direct impact of this on the economy, markets, or politics will be minimal, the psychological significance—Reiwa translates to "beautiful harmony"—is important. It represents a symbolic clean slate for Japan, drawing a line under the beleaguered 30‑year Heisei era. Given the positive economic and market changes already underway, Japan now has the potential to redefine itself and its role in the world.
Overcoming a History of Policy Inertia
While authorities have been slow to adopt pro-growth policies, the Shinzo Abe-led Liberal Democratic Party (LDP) has successfully broken the long-held tradition of policy inertia on this front. Key among these is attempting to deal with the economy's structural challenges, where a range of encouraging measures have been implemented, including:
- Lower corporate tax rates
- Enhanced corporate governance code
- Initiatives to encourage married women and foreign workers into the labor force
Improving Governance Supports Profit Growth
An increasing number of companies are defying skeptics by transforming business practices and governance standards. We believe this can help corporate profit growth and generate improving shareholder returns. The volume of shareholder buybacks is increasing while merger and acquisition activity also shows promise.
From an investment perspective, the equity market is now supported by strong growth in company profits. Indeed, aggregate corporate profits have been exceptional over the past decade, with Japan breaking away from its history of lower returns to converge with the profitability levels of global market peers.
The quality of Japanese companies, both in terms of governance standards, and returns for investors, has continued to rapidly improve, closing the gap with Europe and U.S. equity markets. Over the past five years, for example, the return on equity from Japanese companies has almost doubled. Companies are allocating capital more efficiently, paying higher dividends, and increasing share buybacks, and these improved returns are attracting greater foreign investment.
Global Growth Environment Remains Supportive
As well as market‑specific drivers, the condition of the global economy remains a key factor supporting the Japanese equity market. An environment of modest global growth should continue to help corporate Japan perform well. We are, however, mindful of the trade‑related tensions between the world's two largest trading partners, China and the U.S., and any escalation here is a key risk. While the ideal scenario is that trade war concerns subside and sanctions are lifted, we believe a quality bias will hold us in good stead should the trade situation deteriorate.
Looking ahead, increasing dispersion between stocks is likely to be a feature and will need to be navigated accordingly as the market digests subtle changes to the macro environment and reacts to any specific surprises or disappointments. We continue to believe that investing in durable and improving businesses that are capable of weathering economic turbulence is an advantaged approach in Japan.