The world’s best market
Japan puts Western economies to shame and offers good value for both equity and bond investors, says Max King
When, in 2011, I last came to Japan, the Nikkei 225 index was at the bottom of a long bear market, having fallen by 75% in 22 years. Periodic rallies had not been sustained as, it was commonly agreed, most Japanese companies were not run for profit. Protected from shareholders and predators by cross-holdings, boards focused on themselves and staff loyalty.
Government bonds yielded just 1.25%, the lowest in the world, which seemed absurdly overvalued given Japan’s high government debt relative to the size of the economy. Many had sold bonds short in the expectation of higher yields but this trade became known as “the widowmaker” as it had persistently failed.
The yen was trading at 120 to the pound, making Japan seem expensive, and the economy had stagnated for 20 years. Japan had to change, everyone thought, and become more like the West rather than languishing in outdated social, political and economic structures.
It didn’t take long to realise how wrong this view was. The Japanese economy expanded slowly because the population was falling, so growth in GDP per capita was competitive with other Organisation for Economic Co-operation and Development (OECD) countries. Low population growth was partly the result of negligible immigration but Japan’s reluctance to open its doors will have attracted the envy of countries, such as the UK, suffering housing shortages.
An almost total absence of crime meant low expenditure on law enforcement and security while the number of lawyers, just one tenth in relation to population compared with the UK, suggests a lot less waste of resources in litigation, regulation and compliance. Japan, it seemed, had never closed a railway line, which resulted in superb public transport. Needless to say, the railways are privately run.
The service sector was regarded in the West as absurdly overstaffed, disguising unemployment, but what that meant was outstanding service. Japan’s vast cities were possible because neighbourhoods were selfcontained, with residents not needing to drive out to hypermarkets and retail parks. Far from Japan moving to the Western layout, the reverse is taking place.
A culture of zero inflation
Most important of all was the culture of zero inflation. Prices for the same goods were the same almost everywhere and didn’t change. It didn’t occur to businesses to raise prices. If they had, customers would have walked away.
I came back to the UK thinking that Japanese bonds, far from being overpriced, were good value given zero inflation, and so it proved; the Japanese economy was no basket case and, as its companies evolved, equities would perform strongly over the long term.
Twelve years on, the numbers have changed. The Nikkei 225 index stands at 27,500, up from 10,000 12 years ago and yields 2%. The yen has fallen to 167 to sterling, limiting the equity gains for UK investors, but now looks far too cheap. Japan is now an inexpensive country to visit, while living according to Western habits and tastes has gone from expensive to reasonable, and living as the Japanese do has gone from reasonable to cheap.
Annual inflation is no longer zero but, on the latest numbers, just 3.3%. This is the result of higher energy costs but the reopening of Japan’s nuclear reactors, closed in 2011, will reduce its dependence on imported energy. Ten out of 33 have reopened and another 16 are awaiting approval. The culture of zero inflation hasn’t changed. With little immigration, property prices are low and renting is eminently affordable.
The number of tourists is now a multiple of the number 12 years ago and the country is much more international, and thus easier to navigate. This must have fostered significant growth in the small businesses that service this change and technology has affected the economy as much as anywhere else – notably in cashless payments. Growth is therefore very visible.
Petrol costs just £1 a litre and there are very few electric vehicles. On the other hand, there are few big fat cars and a vast number of compacts, most of them hybrids. Overall, Japan has probably been more successful at reducing hydrocarbon consumption in road vehicles than the UK.
Everything works. Public transport is always bang on time, there are public conveniences everywhere (even at the top of a mountain I climbed), vending machines for drinks are ubiquitous and assistance for travellers is always at hand. Courtesy is deeply ingrained in the Japanese culture.
Perhaps most importantly, Japan appears at peace with itself. Change happens slowly but the direction of travel is one way. This must be a godsend for businesses and citizens, making planning for the future simple. It is a crowded but immaculate and beautiful country.
For those keener to invest than to visit, the prospect is equally attractive. With the yen so cheap, currency appreciation is likely to add to returns, rather than lower them, as it has for the last 12 years. The stockmarket trades on about 12 times prospective earnings, more expensive than the structurally and politically challenged UK market but considerably cheaper than the US. Moreover, companies are much more focused on profits. Thirty-year government bonds yield 1.35% but ten-year yields, negative three years ago, are still under 0.5%. Don’t be so sure that this is unattractive compared with 3.5% on ten-year US Treasuries or 3.8% on UK gilts; the big return should come from long-term currency appreciation.
Investment in Japan will never again be as exciting as it was in the 1980s, when for a time it constituted around half of global indices. But for steady long-term returns it is probably the most attractive of all developed markets across all asset classes.
“The Nikkei 225 index has risen from 10,000 to 27,500 in 12 years”