“As the sun sets on Japan’s powerful stock market rally, investors might ask what could rekindle the lost energy,” begins a Lex column in the April 20 Financial Times. What, indeed?
The Lex team reprise a rather tired “better corporate governance” theme. They report that Japan’s Diet is likely this year to amend the Companies Act to push companies to increase external directors and set up audit committees “more typical of western companies.” More usefully (see below) they note the January launch of “a new JPX-Nikkei 400 share index, comprising Japanese companies that combine higher returns on equity and good corporate governance.”
To the question where the Japan market’s mojo has gone, an analysis by Maeda Masataka, a member Nihon Keizai Shimbun’s editorial board, published on April 23, is edifying, if not particularly reassuring. Maeda observes that one year and five months the launch of “Abenomics,” the Japanese stock market seems to have settled into a low trading volume funk, with no perceptible rallying factor on the horizon.
More troubling and surprising, perhaps, Maeda notes that when exchange rate changes are considered, even during the past 1.5 years returns from French and German stocks exceeded those from Japanese equities, and on the April 22–the day before President Obama touched down for a “state visit” in Tokyo–U.S. equity market returns also pulled ahead of those of Japan.
In short, Prime Minister Abe’s message to the investing world that “Japan is back” has become increasingly suspect, if not unbelievable.
Maeda writes that if we create an index putting a value of 100 on the level of the Nikkei 225 stock average on November 13, 2012, the day before Abe’s predecessor, Noda Yoshihiko, announced dissolution of the Diet lower house and new general elections (i.e., the “pre-Abenomics” market level), by April 18, 2104 that index value would have risen to 167.60. By comparison, against the same dates, the Germany’s DAX has risen to 184.61 and France’s CAC 40 has risen to 181.70.
The DAX is calculated with dividends reinvested, a little discounting is necessary. But the result for investors and particularly Japanese investors (given the appreciation of the Euro vs. the yen) is painfully apparent: Abenomics notwithstanding, they would have done better investing in Europe.
The Dow Jones Industrial Average closed on April 17 at 16,408, which was 166.12 on Maeda’s index, within a point of the Nikkei’s 167.60. (Actual Nikkei closing on the 18th was 14,388 yen. It closed today, April 28, at 14,288 yen.) Maeda’s prediction was that the Dow was set to outpace the Nikkei, and he has been validated.
What has happened to the Tokyo market’s mojo? Maeda suggests, first, that the economics market’s rise was not unpinned by a positive reassessment of individual companies’ management capability. Rather, it was the inverse affect of yen depreciation. While buying stocks when export earnings were being buoyed by a weakening yen made sense, the increase in reported earnings was not definitive evidence of enhanced in corporate strength.
Of course, among the 3500 listed Japanese companies, there are many exceptionally well-managed companies that did attract new investments. Maeda notes, however, that during the 1980s, a time when Japanese companies were genuinely strong, their stocks continued to rise even as the yen appreciated.
“In other words,” writes Maeda, now “unless we Japanese are selling our labor at a discount, overall stock value will not rise. This is a big difference with German stocks, which are rising despite a rise in the Euro. It shows that Japan’s corporate revival is only half-finished.”
As a second point, looking at relationships of the Dow and Nikkei averages, Maeda reckons that short term foreign investors, and particularly hedge funds, were attracted by the promise of Abenomics, and became big net buyers during its first year, but that they have turned this year into net sellers.
Foreign investors have lost patience and been put off by what they see as gridlock in delivering Abenomics’ “third arrow” growth strategy reforms. What these investors are looking for is a “three set” menu of continued BOJ monetary stimulus, a cut in the corporate tax rate, and a successful conclusion to the TPP trade talks.
Maeda observes that many, if not most, long term foreign institutional investors–pension funds, mutual funds, and value investors–remained skeptical toward Japanese equities and did not greatly increase their portfolio allocations. He cites U.S. Treasury data showing that in September 2011 Japanese stocks made up 9.7% (USD 420 billion) of U.S. residents’ USD 4.32 trillion of foreign equities holdings. As at January 2104, Japanese equities had increased to USD 590 billion, but U.S. holdings had increased to USD 6.31 trillion, so the percentage had fallen to 9.4%.
Maeda acknowledges that by October 2012, Japanese stock allocations in U.S. portfolios were at a nadir, a mere 7.6% (USD 390 billion) of a total USD 5.13 trillion. In this sense, what happened since can be seen as a reversion to mean, rather than buying into Abenomics by long term investors.