Finding Opportunity In Japan’s Recovery by Robert McConnaughey, ColumbiaManagement
- In Japan, there is general optimism for a steady economic recovery, with a prevailing sense of confidence in reasonable valuations and a low bar for incremental improvement.
- Companies that can take advantage of global business opportunities look far more attractive than those simply waiting for a rising national tide to lift their boats.
- A re-allocation towards riskier assets from the national pension funds and insurers would create very large inflows to Japanese equity markets.
I travelled to Tokyo in the last couple weeks to get a read on the progress of Abenomics and Japanese recovery. After 20 years of malaise, the country is working to shake off the dust and reassert itself on the global stage. But given the challenges they face, it is not a simple path.
At every turn, there was a pervasive optimism about the direction of the country. The overall expectation from company managements was for a steady recovery in Japanese economic activity. As for investor sentiment, conference attendance was high, and there was a prevailing sense of confidence in reasonable valuations and a low bar for incremental improvement.
That said, updates on current results and corporate guidance were quite modest and may lag growing expectations. Some of that is the hangover effect from the recent consumption tax hike (claims of bad weather effects too, a globally convenient rationalization); but across a broad mix of companies, the general ability to drive revenue growth wasn’t very impressive. If there was a silver lining to this near- term weakness, there seemed to be building consensus around a postponement of the next planned consumption tax hike penciled in for this fall.
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While there was a lot of self-congratulatory discussion about corporate reforms, real action has been painfully incrementalist so far. Adding one or two “independent” directors to fairly captive boards, making a few senior female hires, and paying lip service to an increased focus on shareholders and return on equity (ROE) goals are not exactly earth-shaking. In fairness, while progress may be slow, at least there is positive momentum with encouraging ongoing pressure from the government. There is reason for hope for the intermediate/longer term. Still, it is a very slow-moving evolution and arguably not at levels that match nearer term investor optimism.
One striking theme was the continued risk of an insular edge to overall Japanese corporate culture. Many have commented on the Galapagos effect, a tendency to retreat inward and not connect well in design or execution with global opportunities. I saw many examples of management hope for a recovery serving to reinforce this behavior. Quite a few companies facing global competitiveness challenges pointed to their high market share in Japan; while they are hopeful for a rebound in aggregate domestic growth, they aren’t offering much of a game plan to address the challenges in the bigger picture. This struck me as a dangerous collective behavior in an increasingly globalized world. That said, I saw some noteworthy exceptions to the insular mindset. First, Prime Minister Abe has tirelessly travelled the world in the last year, meeting with heads of state. Clearly, he is motivated to raise national morale, shore up the political base and signal a Japanese resurgence to the world. However, beyond the photo ops, some of the diplomatic efforts were more practical — for example, the potentially synergistic relationship with India. India has a huge and relatively young population (vs. Japan’s worrying aging trends); India needs to build out infrastructure (a Japanese strength in areas such as trains); India excels in IT services and software (vs. Japanese hardware skills); India wants to better compete with China (a common interest with Japan). Japanese companies that can extend their footprint to take advantage of these sorts of opportunities look far more attractive to me than those simply waiting for a rising national tide to lift their boats.
Finally, we shouldn’t overlook Japan’s abundant cash. Corporate balance sheets are strong, individual investors have massive savings and the national pension funds/insurers are enormous (with extremely conservative current allocations). While individual investors show few signs of increasing their risk exposures within Japan (actually the opposite), corporates do seem to be at least talking about ROE and balance sheet optimization (with M&A as an interesting sub-theme). Perhaps more powerful in the near term, Abenomics’ big stick is pension fund reallocation towards equities. In a recent Wall Street Journal editorial, Abe mentioned the possibility of pension fund reform in order to “fortify the people’s confidence” — which I thought was the real clincher to his case.
So, within this backdrop, what stands out as actionable themes?
1. Exceptions to the averages. In a sea of very cautious corporate presentations, radical thinking and globally advanced ideas tend to leap out in contrast. There are such companies in Japan, particularly in areas such as robotics, internet services and alternative energy.
2. Domestic infrastructure plays. It is clear that there will be a very significant reinvestment in Japan’s infrastructure, with the 2020 Tokyo Olympics as a catalyst.
3. Respecting the power of pension/insurance reallocation towards risk assets. The technical power of pension fund cash reinvestment should not be underestimated. One may be skeptical about the long run success of a Japanese turnaround, but the near-term buying power commands respect.