For Daisuke Nomoto of Columbia Threadneedle, low interest rates in Japan are a favorable environment for companies that need to refinance.
Was the Japanese stock market among the big winners in the first half of this year? What is happening in the second half of the year and what should we expect for 2025? An update on the Japanese economy and stocks with Daisuke Nomoto, Global Head of Japan Equities at Columbia Threadneedle Investments, who spoke during a recent visit to Switzerland.
Japanese stocks are among those of developed countries which have recorded the best performances since the start of the year (around +16% since the start of January for the Nikkei 225). Only American technology stocks (+22% since the beginning of January) and American stocks (S&P 500) have done better so far. How can we explain the renewed appeal of Japanese stocks?
Many investors have begun to realize again the attractiveness of the Japanese market which combines several unique advantages. We have brought together these different strengths using what we call the 5 “lows”. First, corporate balance sheets are characterized by low debt levels. This gives them flexibility when they want to invest or return excess cash to their shareholders.
Second, leverage is low at the household level. The Japanese are, on average, little exposed to the stock market. Only 10 to 15% of financial assets invested by Japanese households are placed on the stock market, compared to a share of around 20 to 25% in Europe, a proportion which even reaches between 40 and 50% in the United States. In other words, there’s still money to invest – and that’s even more so because a tax-efficient investment program called NISA (Nippon Individual Savings Account) which exists in Japan makes investments more tax attractive compared to savings.
“I don’t think investors should be too worried about the yen right now.”
Third, expectations are still relatively low about Japan. However, since “Abenomics”, various reforms have been put in place but they have not really been recognized. Fourth, interest rates remain low. Even if they were to rise again, starting from 0.25%, they still remain well below the levels observed in the United States. Inflation on an adjusted basis is still negative based on 10-year bond yields in Japan – this is a very favorable environment for companies that need to refinance.
Fifth, valuation levels are low compared to many other markets. About 40% of stocks have a price-to-book ratio below 1, for example.
The stock market in Japan is the only one that can boast of these five characteristics, namely these 5 “lows” in the positive sense. The Japanese stock market is also not dependent on a single sector; there is no single theme, such as semiconductors or artificial intelligence (AI) that is leading most of the upward movement as is the case for the stock market in the United States currently. Finally, even though Japan’s GDP as a whole is not growing at a spectacular rate, corporate profits nevertheless show one of the highest growth rates among industrialized countries over the past decade.
What role does the strength of the yen – relative to the dollar or euro – play in the attractiveness of Japanese stocks?
Given the low level of interest rates in Japan, speculative investors tend to create downward or “short” positions in the yen against the dollar, which can sometimes result in high volatility in exchange rates. Many companies have calculated their budget with a range of around 140 to 145 yen per dollar compared to around 154 yen per dollar currently. This leaves room for companies to maneuver in case the yen appreciates further against the dollar again. That’s why I don’t think investors should be too worried about the yen right now. Furthermore, even if the yen were to appreciate again, much depends on how quickly this appreciation would occur. For example, Japanese companies could react by changing the prices of their products or by modifying their production base.
“We very quickly came to the conclusion that the correction at the beginning of August was due to an unwinding of speculative carry trade operations.”
At the start of August, we saw a sharp fall in Japanese stocks, followed by an equally rapid rebound. What lessons can we learn from this short-term correction?
We very quickly came to the conclusion that this correction was due to an unwinding of speculative carry trade operations. Between the beginning of July and the beginning of August, the price of the Japanese currency fell from 161 yen to around 145 yen. Was it such a dramatic move for business? No. On the other hand, between mid-July and early August, the Nikkei 225 index fell by almost 25%. It was thus relatively clear that the fall in the stock market had been far too sharp compared to the possible impact that the appreciation of the yen against the dollar could have had on the profits of Japanese companies. Moreover, this correction occurred at a time when the financial system, as a whole, was stable. We therefore rather used this situation to take advantage of this market dislocation and to reallocate certain amounts towards securities whose price seemed to us to have become more attractive again.
Do such opportunities arise often?
On this subject, it must be made clear that we act primarily as a “stock picker”. We purchase securities individually based on their intrinsic value. We are not traders who buy and sell securities quickly based on market developments. In this case, the massive sell-off that occurred on the markets in early August had all the characteristics of an indiscriminate sale of securities. At that time, the securities of certain companies suddenly appeared much more advantageous given the fact that their price had changed while the business model had remained unchanged.
Politically, there have been several changes in Japan in recent months. Is this something to consider as a foreign investor when considering investing in Japanese stocks?
Indeed, there have been several important events, including the recent re-election of Ishiba Shigeru. The prime minister was confirmed in his post in a parliamentary vote even though he will have to govern without an absolute majority. From this point of view, one could say that the political situation in Japan has been slightly unstable recently. Additionally, the ruling party will have to negotiate with other blocs.
“Automation, for example, has excellent development potential. Japan is a country with an elderly population and companies really need to be able to continuously improve their productivity through automation.”
However, regardless of the party in power and its supporters, the decisive question that will arise will be that of the results of its policy on the economy and in matters of national security. The Ishiba government appears to be focused on raising wages and avoiding a return to deflation, which is reassuring.
Is deflation still a cause for concern for the Japanese today?
It depends who you ask! If you ask people who are already retired, this will not be their main concern. On the other hand, if you ask young people, investors or business leaders, the answer will be completely opposite. Many people in Japan know that deflation is a bad thing because both businesses, the economy as a whole, and the government need growth. However, deflation is the exact opposite because it encourages both private actors and households to wait, hoping that prices will fall further. No one wants to act when deflation continues. Fortunately, Japan came out of this situation. China now finds itself in a bit of this situation and hopefully they can get out of it more quickly than was the case in Japan.
If we approach the question of investing in Japanese stocks in sectoral or thematic form, which areas or branches seem most interesting to you currently?
Once again, we have a bottom-up investment approach, or “bottom-up” as it is called in English. We do not invest in sectors but in companies. That, a few areas we think are interesting right now when it comes to Japanese stocks.
Automation, for example, has excellent development potential. Japan is a country with an elderly population and businesses really need to be able to continuously improve their productivity through automation.
Another example of an interesting topic is data traffic, which is growing at a considerable speed due to developments in AI, the Internet of Things (IoT) or autonomous driving. Between 2020 and 2030, research estimates suggest that the volume of data transmitted will increase 400-fold – this will require huge investments in data centers. Several Japanese companies are well positioned to take advantage of this development.
In the energy space, with the expected significant expansion of data centers, companies that provide products and services that increase the efficiency of power transmission will be well positioned to take advantage of this opportunity for exponential data growth.
In the automotive sector, Japanese manufacturers have certainly not necessarily been at the forefront in electric vehicles – on the other hand, several brands are well positioned in hybrid cars which continue to interest many consumers around the world.
Finally, in a completely different area, certain Japanese financial stocks are also not lacking in appeal because they will benefit from the expected rise in rates. So far, the Bank of Japan’s monetary policy has been very accommodating and experts expect a gradual increase in its key rates.
