Amid the wreckage of Japan’s 2020 comes a tantalizing hint that the year ahead could be an altogether healthier one: stocks are ending this year at levels not seen since April 1991 – 30-year highs.
True, the correlation between equity valuations and the real economy, always tenuous, seems to be weakening as Covid-19 risks intensify. Look no further than the disconnect between a Dow Jones Industrial Average up 7% this year and a US economy flirting with 1929, 20 million coronavirus infections and complete legislative gridlock.
Yet in Japan’s case, investors might not be as irrationally exuberant as those betting on solid profits for corporate America.
The Nikkei Stock Average’s 18% 12-month return, remember, reflects the collective wisdom – or mania – of punters betting on where Japan might be six months out. And in any mental exercise that projects what might be afoot in the third-biggest economy in, say, June 2021, probably looks comparatively good when mulling conditions in the US or Europe.
Japan’s broader economy is, of course, limping into 2021. Yet the Nikkei has a number of plusses going for it as the new year begins.
Tokyo feeds the bulls
One is that Prime Minister Yoshihide Suga’s Liberal Democratic Party will have pumped as much as US$3 trillion of fiscal stimulus into the economy. On top of the $2.2 trillion the LDP deployed in mid-2020 – 40% of gross domestic product – Suga is ginning up another $700 billion of spending.
That jolt, on top of titanically large liquidity infusions from the Bank of Japan, will be kicking in as 2021 gets underway. China’s rebound, meantime, is set to gain momentum. A new Nikkei Quick News survey suggests Asia’s biggest trading power could grow as fast as 8.2%, the highest since 2012.
Japanese stocks can continue to expect a sizeable buy-in from the BOJ and Japanese taxpayers via the ginormous Government Pension Investment Fund. As of early December, Japan’s central bank and the globe’s biggest public investment whale seemed in competition to see who could be the biggest buyer of Nikkei and Topix stocks.
Each held $400 billion-plus stockpiles of corporate Japan’s shares. And each is widely expected to add ever more equities to balance sheets with bond yields stuck at zero.
The resultant wins in the market have been broad-based, says strategist Nicholas Smith at CLSA Japan.
As of mid-November, he says, 70% of non-financial companies listed on the broader Topix index beat their consensus operating profit forecasts. “In aggregate, they beat by a thumping 49%” and “the beat was broad-based,” Smith notes.
The breakdown is 39 industries beat consensus, against 15 that missed. The biggest beat was wireless telecommunications, despite extreme volatility in the returns at SoftBank Group’s $100 billion Vision Fund profits at Softbank Group. Smith also highlights a “strong beat” in autos.
Broadly speaking, though, Smith says, “the outperformance of ‘quality’ growth has got more volatile, but the uptrend hasn’t been broken.” What’s more, he says, the “Topix is no longer a dividend Scrooge and yields significantly more than the S&P 500 – against a lower bond yield.”
Looking further afield, Japan has something else going for it: validation from North Asian rival South Korea.
The roughly 2% topline GDP rate economists expect from Asia’s No 4 economy speaks to its status as a Covid-19 exemplar. The Kospi index’s 30%-plus rally in 2020 could be a good omen for Japan’s 2021.
Though differences between Japan and South Korea tend to dominate the discourse, both giants fish in similar waters in terms of Asian supply chains and efforts to reel in foreign investors.
South Korea’s 2020, it can be argued, reinforces the idea that 2021 could be another solid year for Japan’s stocks. Adding to the optimism is the arrival of Covid-19 vaccines.
Investors buying stocks now “are making new positions for 2021,” says strategist Takashi Hiroki of Monex Securities. Adds Ross Mayfield of Baird Investments: “It’s a kind of broad-based optimism.”
There’s a clear feel-good dynamic from vaccine rollouts and from the arrival of continued stimulus from all directions, Mayfield says.
In the US, for example, direct payments of $600 per person will soon be in the mail. In Seoul, President Moon Jae-in is carrying out his “New Deal” reform program.
In Japan, Suga’s government just unveiled an unprecedented $1.03 trillion annual budget for fiscal 2021, a sign Tokyo is ready to continue opening its wallet in the months ahead.
The good news is that the rally isn’t confined to one particular sector. The Nikkei’s surge is being powered by companies as diverse as Mitsubishi Heavy Industries, Uniqlo apparel maker Fast Retailing and SoftBank Group.
The bad news is that true stability in 2021 is Suga’s to lose if his policy mix doesn’t impress investors.
What needs to be done
The strong yen hardly helps. Though Finance Minister Taro Aso has written a line in the sand at 100 yen to the dollar, its ascent is largely a result of investors betting against US assets.
It’s an added headwind at a moment when deflationary pressures are returning. There’s not a moment to waste for Suga’s three-and-a-half-month-old government.
Really, on any list of global powers disappointed by where they find themselves, relative to expectations, Japan is right at the top. The year 2020, after all, was to be now-former Prime Minister Shinzo Abe’s finest hour.
Abe was basking in the glow of history, only having recently become Japan’s longest-serving leader. Tokyo would host the Summer Olympics for the first time since 1964, giving Japan a solid few weeks in the global spotlight for the right reasons – ie, not a giant earthquake, a radiation crisis or a famous gaijin CEO under house arrest escaping and fleeing the nation.
It was also a year in which the seven-plus-year-old reform scheme dubbed Abenomics was supposed to take a victory lap. Twelve months ago, Japan was boasting its longest expansion since the 1980s.
Though a largely wage-less growth spurt until then, 2020 seemed the year in which Japan Inc might be finally opening its wallet to fatten paychecks and boost investments.
That dynamic, Abe’s boosters argued, would validate his moves to tighten corporate governance. Beginning in 2014, Abe implemented a UK-style stewardship code. His Liberal Democratic Party took steps to give shareholders a bigger voice and prodded corporate boards to hire more outside directors.
It’s a work in progress and, sadly, many of Abe’s corporate reforms lack teeth. As Jeff Kingston at Temple University’s Tokyo campus likes to say: “These Abenomics steps are too voluntary for their own good.”
Yet change comes slowly, especially in Japan where centuries-old sogo shosha conglomerates still dominate.
To regain the reformist momentum, Suga should take a far more hands-on role in containing Covid-19 than Abe did. Though Japan’s caseload is trifling compared with America’s – it’s suffered only 1,800 deaths – Tokyo Governor Yuriko Koike says another state of emergency declaration may be necessary.
The metropolis now averages 1,000-plus new infections per day, threatening consumer and business confidence.
Suga must accelerate Abe’s corporate reforms. One way is to offer tax incentives to companies diversifying boards, sharing profits with workers and working harder to cultivate and reward female talent.
The ruling LDP should do another round or two of direct payments to households. The 100,000 yen ($97) extended to every Japanese in mid-2020 is a distant memory. That would go further toward stabilizing falling consumer prices than any BOJ easing.
This newish government needs to succeed where Abe failed. It should take a big swing at loosening labor markets, cutting bureaucracy and boosting startups and productivity. Whereas Abe slow-walked these and other upgrades, Suga could wow the global smart money with a burst of reformist energy.
Speaking of energy, one of Suga’s standout announcements since taking office was the rollout of a plan to make Japan fully carbon-neutral by 2050. Suga’s government also is mulling an emissions-trading system for automakers to encourage the use of electric cars within this decade.
That would not just create new wealth, but greater economic efficiency to enhance Japan Inc’s competitiveness. As economist Robert Alan Feldman of Morgan Stanley puts it: “Funding the transition to renewables from the savings on imports might well pay for the transition and would also generate Keynesian multiplier effects on the domestic economy from the decline of imports.”
And there’s no more obvious place for Japan to use tax and regulatory incentives than to increase its stable of tech “unicorns.” Any moves to create new economic energy from the ground up could make 2021 another banner year for the Nikkei.
As the markets suggest, the bulls are already pivoting Japan’s way. To keep up with them, Suga’s government needs to hit the ground running in 2021.