Japanese Equities
Debunking the Myths
Time was when Japan was the logical choice for a global equity investor seeking to
diversify out of the US and Europe. After all, it was the world’s second-largest
economy for almost a half century, and Asia’s largest by far. It was home to a number
of companies that had built formidable positions in key global markets, such as
automobiles and electronic appliances.
But fast-forward to the present, and the country seems to be a shadow of its former
self, leapfrogged by China in terms of economic scale and lacking the dynamic
growth seen in other emerging-market economies (Display). Public finances appear
to be in tatters, particularly when taking into account unfavorable demographic
changes. Political leadership has been conspicuously scarce, with the tenure of the
last five prime ministers averaging less than a year. The recent earthquake and
tsunami, which devastated the northeastern seaboard in March 2011 and triggered a
crisis at the Fukushima Dai-ichi nuclear power plant, added to the grim picture.
(continued)
Is Japan Becoming Less Relevant to the Global Economy?
Composition of Nominal Global GDP (1990 vs. 2010)
1990
IN THIS PAPER
Japan seems to have fallen out of
fashion among global equity
investors over the past decade,
beset by socioeconomic woes at
home and outshone by rapid
growth in Asian emerging-market
economies. The recent earthquake
provided another setback. In our
view, however, much of the talk
about Japanese companies’ demise
is greatly exaggerated and the
market offers a significant opportunity for investors, particularly those
who base their decisions on
bottom-up company research.
2010
28%
23%
26%
Masahide Ooka
32%
Senior Portfolio Manager—Value Equities
1%
2%
2%
2%
3%
9%
14%
26%
EU
US
Japan
23%
9%
China
Southeast Asia
India
Other
As of April 26, 2011
Source: International Monetary Fund (IMF)
For financial representative use only. Not for inspection by, distribution or quotation to, the general public.
Investment Products Offered
• Are Not FDIC Insured • May Lose Value • Are Not Bank Guaranteed
SEPTEMBER 2011
Display 1
GDP Growth and Market Returns Are Lowly Correlated
Relationship Between Market Returns and GDP Growth of Major Economies
30
Annual Market Return (%)
At the same time, many investors are asking themselves
whether it is prudent to simply remove Japan from their radar
screens. What is really behind the gloom? How much of it is
based on fact, and how much of it is just perception? Is the
country still a worthwhile investment destination? Is it a good
time to buy Japanese assets?
In the following sections, we will tackle some of the popular
misconceptions that seem to have deterred many investors from
Japanese equities in recent years.
A number of assumptions need to be questioned:
n
n
2
First, investing in Japanese stocks is about buying Japanese
companies’ earnings—not about buying the Japanese
economy. Historical data show that the correlation between a
country’s GDP and stock-market returns has been low and
volatile around the world (Display 1). This is unsurprising,
given the growing proportion of earnings that large companies make from their overseas operations, as well as changes
in the companies’ leverage and valuations.
Second, not everything about a population contraction is bad.
A smaller workforce and its changing composition may act as
an incentive for companies to transform themselves in order
to improve efficiency and profitability. The Japanese service
industry, whose productivity has been notoriously low relative
to that of powerful, export-oriented manufacturers, has
plenty of room to benefit from innovation. Changing
demographics may also lead to a shift in consumption to
higher-value-added segments or invention of products and
services that meet previously ignored needs in the society.
Japanese Equities
10
1970s
1980s
1990s
2000s
0
–10
–20
–6
Myth No. 1:
Shrinking Population Means Dearth of Opportunity
One reason that many observers cite for Japan’s anemic GDP
growth in recent years and bleak prospects in the coming
decades is the rapidly aging population. It is true that Japan’s
population began to contract in 2005 (see “The Graying
Society”, page 4). The working-age population began to shrink
even earlier, and that may negatively affect the country’s
economic growth by reducing domestic personal spending and
constraining labor supply. But will a declining population
necessarily translate into lower equity returns?
20
–4
–2
0
2
4
6
Real GDP Growth (%)
8
10
As of December 31, 2010
Historical analysis and past performance does not guarantee future results.
Source: Credit Suisse Global Investment Returns Yearbook 2010
n
Third, Japan will not be alone in facing these demographic
challenges. In many Asian countries, including China and
South Korea, the working-age population will soon begin to
shrink. Japanese companies that successfully reinvent
themselves, creating products that cater to the new population mix, have a good shot at growing earnings by leveraging
their expertise elsewhere in Asia.
History shows that many Japanese companies have successfully
adapted to the new challenges posed by rising competition
from other Asian players over recent decades. For example,
many consumer-goods companies have benefited from the
growing wealth of the middle class in emerging-market
countries, and a broad range of industrial companies have
thrived on supplying critical components or services to finalgoods makers in such countries. Moreover, Japanese companies
remain among the most innovative in the world, as their patent
filings indicate (Display 2).
As a result, a number of companies have gained dominant
positions in lucrative high-growth markets ranging from factory
automation systems to state-of-the-art medical equipment to
consumer goods such as diapers that use superabsorbent
polymers. We believe that these capabilities can be successfully
applied to the new challenges of an aging world.
For financial representative use only. Not for inspection by, distribution or quotation to, the general public.
Display 2
Display 3
Japanese Companies Keen to Stay on Cutting Edge
Japanese Companies’ Profitability Has Been Improving
Netherlands 4
Japan
31
France
8
Germany
14
40
14
30
10
Myth No. 2:
Japanese Companies Just Aren’t Profitable
Another widely held myth is that Japanese corporations have
suffered a continuous decline in profitability. Our research
spanning the last few decades suggests that this is far from the
truth. Since fiscal year 2001, Japanese corporations’ profitability
has been improving at a rapid pace, although it did take a
temporary hit during the credit crisis (Display 3).
Excluding the impact of extraordinary losses and taxes, the
actual turning point came in fiscal year 1992, shortly after the
end of the so-called bubble-economy era. Actions such as
raising asset turnover by controlling capital spending and
making more disciplined use of cash have led the underlying
profitability of Japanese corporations to improve for almost two
decades. We believe this momentum can be sustained.
Myth No. 3:
Japanese Companies Can’t Cope with a Stronger Yen
Japan has run current account surpluses for many years. Partly
as a result, the yen has risen significantly since Japan moved to
a floating-exchange-rate regime in the early 1970s. Initially fixed
at 360 to the US dollar, the yen now trades near 80. But this
trend is unlikely to continue indefinitely. The Bank of Japan is
likely to lag other central banks in raising interest rates from
their current rock-bottom levels, given the persistent deflationary
6
2
10
Operating Income (Left Scale)
0
US
25
As of December 31, 2010
Source: World Intellectual Property Organization and AllianceBernstein
ROE
20
Percent
South Korea 4
71
76
81
86
91
96
–2
01
12E
06
As of December 31, 2010
Past performance and current estimates do not guarantee future results.
*TOPIX excluding financials
Source: Tokyo Stock Exchange and AllianceBernstein
pressure in Japan and the need to support reconstruction efforts
with a generous monetary policy. This should help reduce upward
pressure on the yen in the medium term.
Of course, if the yen’s rise continues, exporters will see their
overseas revenue decrease in yen terms. But they have learned
over many years to adapt to this headwind, notably by increasing
offshore production. In an example bound to be followed by its
rivals, Nissan Motor now imports the March (aka Micra), one of its
Display 4
Many Exporters Have Learned to Live with a Strong Yen
Nissan Motor: Exports as Percent of Total Unit Production
50
40
Percent
Other
15
Japanese Companies’ Return on Equity and Operating Income*
Yen Trillions
Top 101 Firms in International Patent Application, by Country
30
20
Net of Effect from Importing
March/Micra Model from Thailand
10
84
88
92
96
00
04
08
12E
As of September 30, 2010
Historical analysis and estimates do not guarantee future results.
Source: Company reports and AllianceBernstein
For financial representative use only. Not for inspection by, distribution or quotation to, the general public.
3
main subcompact models in the domestic market, from its
manufacturing plant in Thailand. As a result, the company’s
earnings from exports have declined to just 15% (Display 4,
previous page). More and more companies locally manufacture
products for overseas markets to avoid the currency impact and to
better adapt to the local climate. Thus, the profitability of Japanese
companies’ overseas subsidiaries has been steadily rising over the
past several years despite a generally rising trend in the yen, which
has made exported products more expensive (Display 5, page 6).
The Graying Society
Japan is the first developed modern-era economy that has
entered a sustained population contraction. Moreover, its
population pyramid is inverted—there are fewer younger
people and children—which means that the populace,
notably the working-age generation, is bound to continue
shrinking. Neighboring Asian countries will be closely
watching how the society copes with this problem as the
same challenges loom in China, due to its one-child policy,
and in many other countries (Display).
Security Research, the population is expected to decline to
95 million by 2050. More importantly, the number of
working-age people (15 to 64 years old) peaked even
earlier, in 1995. And their proportion of the total is set to
decline, while that of people over the age of 65 is rising. By
2050, each pensioner will be notionally supported by barely
more than one worker through contributions to the
pay-as-you-go pension system and taxes. It doesn’t sound
too good to be young.
Japan’s population fell in 2005 for the first time since the
end of World War II, peaking at about 130 million. According to the National Institute of Population and Social
Against this backdrop, one of the more realistic objectives
for policymakers and businesses, in our view, is to increase
the per-capita GDP by improving labor productivity, boosting
Aging Population Poses Challenge to Many Asian Nations
Population Pyramid
Japan (2010)
Age
Male
China (2030E)
Female
Male
Female
85 and Above
80–84
75–79
70–74
65–69
60–64
55–59
50–54
45–49
40–44
35–39
30–34
25–29
20–24
15–19
10–14
5–9
0–4
6,000
4,000
2,000
0
2,000
4,000
Thousands
6,000
80,000
40,000
0
40,000
80,000
Thousands
Japan display as of January 1, 2011; China display as of December 31, 2009
Source: Ministry of Internal Affairs and Communications, and US Census Bureau
4
Japanese Equities
For financial representative use only. Not for inspection by, distribution or quotation to, the general public.
There is now a growing consensus that women and the
elderly should be encouraged to stay in the labor force.
Extending the retirement age now seems a certainty—without it, the pension system will not hold up, and the
pensioners themselves may not have enough savings to live
on pension income alone. That is bad news for those who
want to head out to the beaches, but it would provide some
relief to the labor-shortage concerns.
The gender front is somewhat encouraging as well. A
drooping section in the so-called M-curve, which plots the
labor-participation rate of women by their age, has historically been more pronounced in Japan than in most developed economies, as social conventions and tax breaks
encouraged women to stay home after having children. But
the dip, for women in their 20s and 30s, has become much
less acute over the past decade (Display, right). Cynics may
argue that this is only because of a precipitous decline in the
husbands’ income. They may also contest that the change
might exacerbate the dwindling birthrate. But it is also true
that more women are opting to continue pursuing lifelong
careers than in previous generations, and that there is plenty
of room for employers to make the workplace more
attractive to working mothers.
Immigration, as is the case in many other developed
economies, is a touchy issue. But the business community is
generally in favor of importing labor. There may never be a
national consensus on large-scale acceptance of immigrants,
but many factories, service industries and even farms are
already using loopholes in regulations to procure low-cost
imported labor.
More importantly, an increasing number of companies are
hiring non-Japanese executives for senior management
positions as they seek to become truly global. Over time,
such efforts may help to “de-nationalize” Japan’s demographic problems.
More Women Are Staying in the Workforce
Women’s Labor-Participation Rate (by Age)
80
2009
60
40
1999
20
0
–1
9
20
–2
4
25
–2
9
30
–3
4
35
–3
9
40
–4
4
45
–4
9
50
–5
4
55
–5
9
60
–6
4
65
+
consumers’ spending power and attracting more foreign
investment and talent. This is easier said than done, of
course. But history, including the Meiji Restoration modernization in the late 19th century and the reconstruction after
World War II, suggests that daunting adversity can be the
greatest catalyst for a major transformation in Japan.
15
For many decades, Japanese corporations tended to have
several friendly companies hold a significant part of their shares
and return the favor by holding those companies’ shares, in a
practice known as “mochiai.” This cross-shareholding convention was partly aimed at strengthening strategic partnerships,
but also at mutually securing stable, nonhostile shareholders,
which insulated the companies from many of the pressures that
have forced businesses in other countries to give higher priority
Percent
Myth No. 4:
Japanese Companies Don’t Care About Shareholders
As of December 31, 2010
Source: Ministry of Internal Affairs and Communications
For financial representative use only. Not for inspection by, distribution or quotation to, the general public.
5
to shareholder returns. This began to unravel in the 1990s,
however, as the impact of mark-to-market losses from such
shareholdings eroded the companies’ capital (Display 6).
Display 5
Localization Keeps Overseas Business Immune from
Higher Yen
Current Profit Margins of Japanese Companies’ Overseas Subsidiaries
7
Southeast Asia
6
Percent
5
4
Over the past two decades, there has been an increased
awareness in the Japanese business community about the
importance of corporate governance, including the need to
place higher priority on shareholders’ interests. An increasing
number of corporations have made improving return on equity
(ROE) a key management target, while an influential publicpension fund has cited ROE as a key criterion in their investments and proxy voting, adding to the pressure on corporate
management. Given the large piles of cash that many companies
have stocked up on in the wake of the recent global credit crisis
and gradually recovering business confidence, we believe many
businesses will opt to reward shareholders through dividend
payouts and share buybacks in the coming years (Display 7).
China
3
2
Myth No. 5:
A Ticking Debt Crisis Means Investors Should Avoid Japan
US
1
With public-sector debt at 200% of GDP, some investors fear
that Japan will eventually suffer the same fiscal crisis now
afflicting several countries in the euro area. We think these fears
are overstated. Since 95% of Japanese government bonds are
owned domestically, Japan is not dependent on access to
international markets to roll over its debt. In fact, as a nation,
Japan is still the world’s largest creditor—still well ahead of
China as of the end of 2010.
0
02
03
04
05
06
07
08
09
10
Through June 10, 2011
Historical analysis and estimates do not guarantee future results.
Source: Ministry of Economy, Trade and Industry
Display 6
Japanese Companies’ Cross-Shareholdings Have
Been Reduced
Display 7
Japanese Companies Have Become More Shareholder-Friendly
Stable Shareholders in Japanese Companies*
Japanese Firms’ Share Buybacks and Dividend Payouts
60
15
Nonfinancials (Nonfinancial Shares)
20
Nonfinancials (Financial Shares)
5
Banks
0
82
86
90
94
98
02
06
10
Through December 31, 2010
*Nonfinancial companies listed on the first section of Tokyo Stock Exchange for the
entire period from March 2000 to March 2010
Source: Tokyo Stock Exchange and AllianceBernstein
6
Dividend Payouts
10
Yen Trillions
Percent
Share Buybacks
Insurance Companies
40
Japanese Equities
0
99 00 01 02 03* 04 05 06 07 08 09 10 11E 12E
As of June 30, 2011
Historical analysis and current estimates do not guarantee future results.
*Share buyback: June through December
Source: Deutsche Securities
For financial representative use only. Not for inspection by, distribution or quotation to, the general public.
Japan’s current fiscal stance is not sustainable indefinitely. But
this is true of many other developed countries, including the US.
In our view, public-sector debt is no more a reason to avoid
Japanese stocks than to avoid investing in US companies.
A Buying Opportunity?
Japanese equity valuations are now drifting at historically low
levels, and look particularly attractive in relation to global
market valuations (Display 9). The price-to-book-value ratio has
Display 8
Japanese Government Can Raise Tax Revenue if Needed
30
General Tax
25
Local Surtax
Percent
20
15
10
5
ed
Un
it
Un
ite
dS
ta
tes
Ja
pa
n
(N
Y*
Sta
tes )
Un
ite (CA *
dK
)
ing
do
m
Ge
rm
an
y
Sw
ed
en
Gr
e
Sw ece
itz
erl
an
d
Ch
in
Au a
str
ali
a
0
As of May 31, 2011
Includes sales tax, value-added tax and consumption tax
*Includes state surtaxes
Source: Deutsche Securities
Display 9
Japanese Equities Are Compellingly Priced
Price/Earnings
Price/Book
80
6
Ratio (×)
60
Ratio (×)
Of course, as the population ages and spends its savings, this
domestic source of funding will come under pressure. But, if
pushed against a rope, the Japanese government has a number
of options to stabilize its finances. It is important to note that,
ultimately, a government’s creditworthiness is backed by its
ability to collect taxes. And the sales tax in Japan, for example,
is only 5%—among the lowest in the developed economies
(Display 8). Although raising that tax rate will be politically
unpopular, it is an obvious option for improving the fiscal
position. Opinion polls suggest that a majority of taxpayers
understand the need to increase the sales tax, although they
also want the government to curtail wasteful spending before
pulling the trigger.
40
20
0
4
2
0
70 76 82 88 94 00 06
Japan
70 76 82 88 94 00 06
Global*
Through March 31, 2011
Past performance does not guarantee future results.
*MSCI World
Source: AllianceBernstein
been bobbing at around 1.0 for the past two years, which
means that companies are practically trading at their liquidation
value. We believe that many companies have strong enough
fundamentals that make these low valuations will look out of
place once the heightened global market anxiety subsides.
While global investors are rightly concerned about the future
of the Japanese stock market, we believe that much of this
skepticism is misplaced. Changes in many leading Japanese
companies’ business models and their strong competitive
positions are often ignored.
Such an environment, however, may offer patient investors an
opportunity to generate rich excess returns in the long run.
We believe that there is an abundance of companies whose
profitability and growth potential are undervalued. With
rigorous bottom-up company research, based on deep knowledge of global and local industry landscapes, investors should
be well placed to outperform the country benchmark over time.
And, in our view, there is a good chance that the benchmark
itself will fare well against its major global counterparts as
confidence returns to markets worldwide. n
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7
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