Our four-person panel explains Japan’s economic boom, from
growing GDP to corporate sector vibrancy, and which upward trends
will sustain.
----- Transcript -----
Chetan Ahya: Welcome to Thoughts on the
Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.
Japan is undergoing a once in a generation transformation. A
country once associated with its lost decades is now seeing
multi-decade highs for nominal GDP growth and equity indices.
On this special episode of the podcast, we will discuss why we
are so optimistic on Japan's trajectory from here. I'm joined by
our Chief Japan Economist Takeshi Yamaguchi, our Chief Asia and
EM Strategist Jonathan Garner, and our Japan Equity Strategist
Sho Nakazawa.
This episode was recorded last Friday, May 31st at 9 am in Hong
Kong.
Jonathan Garner: And 9 am in
Singapore.
Takeshi Yamaguchi: And 10 am in
Tokyo.
Chetan Ahya: Japan's nominal GDP growth
reached a 32 year high in 2023. Equity markets have reached multi
decade highs, and ROE and productivity growth have been on an
improving trend. Corporate sector vibrancy is returning, and
animal spirits are reviving. A new, stronger equilibrium is one
of robust nominal GDP growth and a sustainable moderate
inflation.
This new equilibrium of stronger normal GDP growth and low real
interest rates will also be supportive of Japan's capex trends.
With that backdrop, let me now turn to Yamaguchi san.
Yamaguchi-san, what makes us confident that this virtuous cycle
of rising wages and prices will continue to play out?
Takeshi Yamaguchi: We think Japan's social
norm of no price hike, no wage hike is changing, and a good
feedback loop between wages and prices is emerging. Workers
demand higher wages with higher inflation expectations and the
corporate management accept their demand, as they also expect
higher inflation. Japan's labor market remains structurally tight
and aggregated corporate profits are now at a record high level.
In addition to the pass-through from prices to wages, we are
beginning to see the pass-through in the other direction from
wages to prices, especially in service prices.
The average wage hike in these spring wage negotiations was the
highest in the last 33 years. So, we expect to see a gradual rise
in service inflation going ahead with a rise in wages.
Chetan Ahya: Could you elaborate a bit on
the details of the capex outlook?
Takeshi Yamaguchi: Yes. We expect Japan's
private capex to exceed its previous 1991 peak this year. In the
previous deflationary period, domestic nominal GDP remained in a
flat range, and Japanese firms mainly invested abroad. That said,
the trend of Japanese nominal GDP growth has shifted up, which
will likely positively affect Japanese firms’ decision to
increase domestic investment.
Also, there are various other factors supporting domestic capex,
such as real interest rates remaining low, the weak yen, the
government's new industrial policy supporting onshoring and
semiconductor investment, and the need for digitalization and
labor-saving investment on the back of structural labor shortage
driven by demographic shifts.
Chetan Ahya: Thank you, Yamaguchi-san. And,
you know, I can't let you go without answering this question,
which is much of the focus of the markets right now. If yen
depreciates to 160 again, how much upside risk to your rate path
do you see?
Takeshi Yamaguchi: Our FX team expects the
yen to gradually appreciate to 146 by the end of 2024, and under
the assumption, we expect one hike this year in July and another
one in January next year. However, if sustained yen depreciation
raises domestic underlying inflation trend, we think the BOJ will
respond by raising the policy rate further to 0.75 per cent in
2025.
Chetan Ahya: Thank you, Yamaguchi-san.
Jonathan, let me come over to you now. You have led the debate on
Japan's ROE improvement and have been bullish since 2018. How are
we thinking about Japan equities from a broader Asia market
allocation perspective now?
Jonathan Garner: Back in 2018, we
highlighted Japan equities as what we called the most
underappreciated turnaround story in global equities. And at the
heart of our thesis was the idea that monetary and fiscal policy
dials were now set to exit deflation, driving an improved
top-down environment for corporations from an asset utilization
perspective.
It's worth recalling that during the deflation era, Japan listed
equities ROE averaged just 4.2 per cent for two decades, by far
the lowest in global markets. That's now reached almost 10 per
cent, and we're confident that by the end of next year we can be
approaching 12 per cent, which would put Japan back in the middle
of the pack in global equity markets.
And we think further re-rating in line with the improved ROE is
likely, over the medium term.
Chetan Ahya: And how much upside do we see
from here?
Jonathan Garner: Well, in terms of the
target price that we published in our midyear outlook, that now
stands at 3,200 for June 2025 for TOPIX. And the way that we
derive that is through an earnings forecast for TOPIX, which is
around 5 per cent above current consensus levels.
And in addition, a forward PE multiple assumption of 15 times,
which is close to where the market is currently trading, and
around about a 4 PE point discount to our target multiple for the
S&P 500. So that gives us around 16 per cent upside versus
current spot levels.
Chetan Ahya: Thank you, Jonathan. And you
mentioned about corporate governance changes helping Japan equity
markets. Sho, let me bring you in here. How will corporate
governance changes drive further improvement in Japan's ROE?
Sho Nakazawa: I would say corporate
governance reform, which is Tokyo Stock Exchange initiative will
help fuel OE gains going forward. From the last year below 1x P/B
has been a buzz word in the market, growing sense of shame and
peer pressure to enhance capital efficiency for the corporate
executives. And this is not just a psychological change. If we
look at cumulative share buybacks amount, last fiscal year it hit
a record high of ¥10 trillion, and we are seeing further record
growth into this fiscal year as well.
Chetan Ahya: And what are the key alpha
generation themes still to pay for within Japan equities space?
Sho Nakazawa: In terms of alpha generation,
we explored three key themes within the Japanese equity
landscape. So one, identifying companies with labor productivity
and pricing power that can pay and absorb higher real wages; and
two, finding the next cohort of corporate reform beneficiaries.
Three, assessing the impact of NISA, Nippon Individual Saving
Account, inflows.
I think this will drive large cap, high-liquidity value and high
dividend stock. Still plenty to play for in Japan.
Chetan Ahya: Yamaguchi-san, Jonathan,
Nakazawa-san, thank you all for taking the time to talk. And
thanks for listening. If you enjoy the podcast, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or a colleague today.
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