Japan's Markets Today
Equity price gains in Japan may be driven by innovation over the long term. Portfolio manager Shuntaro Takeuchi discusses the opportunity set.
With innovation driving equity gains in Japan, Shuntaro Takeuchi, Lead Manager of the Matthews Japan Strategy, remains constructive on the long-term growth potential of Japan's markets.
Q: What sectors and themes do you favor in Japan?
As active investors, we search for opportunities in innovative technology and services, which naturally leads us to the broader technology and health care sectors. Two major themes that we continue to monitor are labor productivity improvements and combating rising health care costs.
Labor populations are peaking in the U.S. and China as the world begins facing issues that Japan has been facing over the last few decades. Baby boomers are nearing 70 years old and birth rates remain at record lows in almost all advanced economies. When you ask which companies have thrived amid a steady decline in labor force, aging society, low birth rates, shrinking domestic demand and deflationary environment, the answer is growth companies in Japan. They have provided solutions to these structural challenges. Successful Japanese growth companies now have the opportunity to grow outside of Japan as these trends are starting to be felt globally.
Q: Japan's broader markets continue to lag U.S. equities. Why has sentiment been weak?
Regarding weak sentiment, we're still in one of the deepest recessions ever. More than half of Japanese corporate profits come from export sectors, which have a high correlation to the global manufacturing Purchase Managers' Index. June quarter earnings results showed some resilience compared to consensus estimates, but at the end of the day, operating profits are still down steeply year-over-year. We do seem, however, to have seen the worst: Month-over-month numbers are slowly improving.
While COVID-19 cases in Japan have been lower than in other developed economies, strict protocols remain in place throughout the country, which could continue to have a dampening effect on the domestic economy in the near term. On a long-term view, however, we remain very constructive on investments in Japanese growth equities.
Q: What's on the horizon for Japan's markets?
For many years, Japanese equities have not been considered a place to invest, but rather a place to trade in and out of. Investors tend to buy Japan when things bottom out and improve, then get out when things start to peak. However, the dynamic has meaningfully changed since 2010 as Japanese corporates have been generating improving levels of profits at the bottom of the cycle. Japan has turned from pure value to cyclical growth, in our view. Many global investors are still skeptical of this change and that's where the investment opportunity lies, in our opinion.
Looking ahead three to five years, we ask two questions: Will the economy get worse or better from now? And will global interest rates begin structurally rising or stay low? The Japanese equity market in our view is a beneficiary of incremental improvement in economic activity and profit growth driven by innovation—not a structural interest rate increase. For the past decade, the Japanese market has consistently outperformed European markets and even the Asia ex-Japan market, driven by these two things. Over a medium-term horizon, we think the answers to both questions will continue to be favorable for Japan.
How resilient are profits generated by Japanese corporates?
The resiliency of profits generated by Japanese corporates today is much greater than during the global financial crisis period. In addition, we expect that innovation will continue to drive equity price gains in Japan over the long term. In our view, an active approach to security selection has always been important when investing in Japan. The pandemic has elevated the importance of security selection, as better managed companies are likely to generate better long-term results as the global economy slowly returns to growth.