London - Although Japan's Prime Minister Shinzo Abe is stepping down, it's likely his successor will continue the country's regulatory and economic policies that have markedly improved corporate governance and financial performance in recent years. As global markets move toward cyclical recovery, we believe investors that allocate to Japan may be well rewarded over time.
A couple of weeks ago, Japan's longest-serving prime minister, Shinzo Abe, announced he would resign due to ill health. Abe's legacy will be long-lived, likely to have the same permanent impact as Ronald Reagan in the US and Margaret Thatcher in the UK. We expect the ruling Liberal Democratic Party's strategy to continue as Abe's close ally, Yoshihide Suga, was elected head of the LDP on September 14. He is expected to become the new prime minister after a parliamentary vote on September 16.
Governance reforms and improved profits
Japan has made some notable improvements in its regulatory framework for corporate governance in recent years. At the same time, we have seen a big push from the country's sovereign wealth fund, the GPIF, to improve financial performance, governance and shareholder friendliness. We have seen labor market reforms, with a focus on female workers. Board structures are being notably revamped, with more independent members. Shareholders are finally speaking up, too, pushing more actively for change.
Collectively, these trends have resulted in a marked improvement in:
- Corporate profitability
- Return on equity
- Dividend pay-out ratios
- Share buybacks
- Accelerating the untangling of corporate cross-shareholdings
Visible change underway
With over half of quoted Japanese companies sitting on net cash positions, a huge amount of capital could be directed into more productive and shareholder friendly avenues. That process has started, and we believe it will continue.
Chris Dyer and I regularly visit Japan to meet with companies. Although our wings have been clipped by COVID-19, we have remained active on our phones and tablets, speaking with corporate officers at existing and potential portfolio companies.
We see and hear the change underway. For any equity investor, positive change and momentum can be exciting ways to find alpha, and we believe Japanese companies are displaying clear improvements in many facets of how they manage their businesses.
Japan's market appears attractive from a valuation perspective. The Tokyo Price Index (TOPIX) trades at 14.4 times 2021 earnings versus the S&P 500, which trades at about 20 times 2021 earnings. The corresponding price-to-book multiples are 1.2x in Japan and 3.7x in the US.
Foreign investors are the most underweight Japan that they've been in eight years, and therein may lie opportunity. Japan stands in stark contrast to the alarming signals of both over-concentration and gold-rush momentum that we see in parts of the US stock market.
Warren Buffett appears to share this view. On his 90th birthday on August 30, he announced that he has spent billions of dollars over the last year building up 5% positions in five Japanese trading companies.
We continue to have strong conviction in the case for international equities. As we have discussed, we believe we are in the early stages of a global cyclical economic recovery. The countries best positioned to benefit from this theme are those with large export economies and deep manufacturing bases. Both Japan and Germany fall into this camp.
Bottom line: Japan's recent path of governance reforms and improving financial performance is likely to be continued by Abe's successor and close ally, Yoshihide Suga. We believe this positive momentum, coupled with a shift toward a cyclical economic recovery, bodes well for Japan's markets and businesses.