The structural reform arrow is still a work in progress, but deregulation, immigration reform, and encouraging women in the workforce are among some of the policies that can help offset the demographic headwinds of an aging population. A strong military is also a part of Abe’s platform — and helped his LDP party win votes over the weekend in light of the North Korean threat — so we could see more defense spending.
Reason #3: Corporate Governance
For many years, one of the big knocks on Japanese stocks was that the companies were not managed for the shareholders, but rather for social good. The corporate culture in Japan has been changing, and increasingly we are seeing companies run more for the shareholders, with smarter capital allocation decisions and more cash returned to shareholders in the form of dividends or buybacks.
For example, since 2006, dividends for the MSCI Japan Index have grown more than 75%, or 5.9% per year — not far behind the equivalent in the U.S. (7.5%). Growth in share buybacks has been even stronger over this period, increasing by more than 150% over the past 10 years, or 9.8% per year, more than five times the growth rate of buybacks for the S&P 500 Index.
Greater focus on return on equity (ROE), a measure of profitability, is another positive development in corporate Japan. Stock valuations and ROE are connected, so companies with large cash hordes and depressed ROEs — like many in Japan — have tended to be penalized with lower valuations. A greater focus on ROE helps provide incentive for companies to put cash on their balance sheets to productive use and may also help support higher stock prices.
Reason #4: Attractive Valuations
In theory, better corporate governance, returning more capital to shareholders, and higher ROE should translate into higher valuations for Japanese stocks. Yet, as shown in Figure 3, the Japanese market is quite a bit cheaper than the U.S. and also cheaper than Europe. On a forward price-to-earnings ratio (PE) basis, the PE for Japan is 14.2 compared with 17.9 in the U.S. and 15.1 for Europe, despite comparable expected earnings growth in Japan. Consensus earnings estimates are calling for 18% earnings growth for 2017 and 7% in 2018.
Pessimism toward the Japanese equity market is another reason it might present an attractive opportunity. According to the latest data on investor positioning, U.S. investors are underweight the country’s equities. In fact, the recent Barron’s Big Money poll — a survey of more than 140 money managers across the country — showed that only 6% expect Japan to be the top-performing market over the next 12 months, the lowest of the five choices (emerging markets, Europe, U.S., China, and Japan). When there are few bulls, the opportunity exists for more to emerge and push stocks higher.