by Grace Huang, Senior Analyst, AGF Investments
Japan’s equity market has been hit hard by the recent correction that has sent most of its global counterparts tumbling as well, but the rout—and ongoing volatility associated with it—hasn’t completely negated an otherwise positive year for many Japanese stocks. In fact, despite falling 25% over the past month, the Nikkei 225 Index has still gained nearly 5% year-to-date and boasts a 12-month gross return of nearly 8%. The big question for investors now is whether Japan can find its footing again.
We believe there are reasons to think it can. A weaker yen versus the U.S. dollar supports Japan’s export-oriented companies. The economy has come out of the COVID-19 pandemic and is growing again. Inflation has returned, and in a country that has grappled with deflation for much of the past 35 years, that is a generally welcome development. Meanwhile, corporate governance reforms, spearheaded a decade ago by now-deceased Prime Minister Shinzo Abe, seem at last to be having an impact on investor confidence.
Yet investors may want to consider one other reality that supports long-term optimism about Japan, and it’s this: in the global competition between economic superpowers to foster and strengthen their domestic semiconductor industries, Japan is winning.
In the digitized, connected economies of today, semiconductors matter – a lot. They are essential components of everything from computers and smartphones to refrigerators and automobiles. Yet as diverse as their applications are, their production is incredibly concentrated. One region – Taiwan – produces nearly two-thirds of the world’s semiconductors and more than 90% of the most advanced chips used in applications like artificial intelligence, according to The Economist. (South Korea, Japan, China and the United States round out the Top 5 chip producing countries.)
The COVID-19 pandemic exposed the inherent vulnerability of the poorly diversified semiconductor supply chain. Manufacturers around the world, including in Japan, could not get the chips they needed, impacting supply and prices in almost every sector and creating ripple effects throughout economies. In 2021 in the U.S. alone, the semiconductor shortage cost the economy an estimated US$120 billion, according to a CBS News report. Meanwhile, geopolitical forces, in particular rising tensions between the U.S. and China, further heightened risks to the chip supply chain. China claims Taiwan as its territory and, in the wake of Russia’s invasion of Ukraine, fears have grown of an emboldened China “repatriating” the world’s epicentre of chip production. As a result, semiconductor supply integrity has become both an economic and a national security issue for the West and for Taiwan itself.
Those factors have spurred policymakers and business leaders to try to dramatically reshape the semiconductor supply chain through massive government support for domestic production. China has launched an ambitious program to subsidize producers in an effort to reduce reliance on U.S. and U.S.-allied chip sources. In the European Union, the Chips for Europe Initiative directs billions of dollars to supporting technology capacity-building and innovation. And in the United States, the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022 earmarks more than US$50 billion for semiconductor manufacturing, research and development, and collaboration with friendly countries to foster domestic chip production.
Japan has not been sitting on the sidelines. While the U.S. has invested almost double the amount in absolute terms that Japan has to date, no country has invested more than Japan in proportion to its gross domestic product (GDP). According to a report released in April by the Fiscal System Council, a subcommittee of the Ministry of Finance, Japan invested 3.9 trillion yen to support the chip sector – about 0.7% of GDP, which is more than the U.S. (0.2%), Germany (0.4%) or France (0.2%).
That investment has already produced tangible results, as the Japanese government and some of its largest companies have actively courted semiconductor giants in South Korea and, most importantly, Taiwan to collaborate on expanding chip production in Japan. In 2022, Japan and Taiwan’s largest semiconductor foundry announced plans for a new chip fabrication facility in Kumamoto. It officially opened in February, a mere two years later – a remarkable achievement for such an enormously complex construction project. Billions of dollars in government subsidies helped, as did Japan’s relatively flexible labour unions and support from its own technology industry titans, as reported by Bloomberg. And Japan’s success at Kumamoto stands in sharp contrast to a planned chip fabrication plant in Arizona – the result of a partnership between the U.S. and the same Taiwanese foundry. That project is well behind schedule, reportedly owing to a host of cultural and engineering roadblocks.
The Kumamoto facility is scheduled to start production later this year, but there is more to come. Just days after the plant opening, Japan announced it was investing nearly US$5 billion with the same Taiwanese foundry to build a second fabrication facility in Kumamoto. The plan is for it to produce more advanced chips when it comes online in 2027.
Meanwhile, a public-private partnership called Rapidus, founded in 2022, is making headway towards the commercialization of ultra-sophisticated next-generation semiconductors. The project is backed by billions of yen in support from Japanese technology companies, as well as 330 billion yen (CAD$2.9 billion) in government financing so far. A pilot production line for Rapidus is planned for next year, with full-scale production slated for 2027.
We believe those developments may place Japan well ahead of other countries in the global competition for semiconductor security, and its early lead could give investors reason to believe that its recent renaissance is credible. For one thing, a secure supply of semiconductors could provide significant economic insurance for an equity market that is dominated by manufacturing, electronics and other technology companies. Yet perhaps more important over the long term are the potential spill-on effects of domestic chip production. With domestic chip production at its core, a robust semiconductor ecosystem could foster a wide array of companies to support and innovate around a growing industry. That could give Japan an innovation edge over other countries as fields such as artificial intelligence, technology personalization and autonomous driving evolve.
Of course, the global race for semiconductor security is far from over. Japan and other developed countries may well face stiff competition from new, lower-cost entrants. For instance, India’s largest conglomerate recently broke ground on two semiconductor factories in Gujurat, via a partnership with another Taiwanese chip producer.
Yet if nothing else, Japan has clearly and quickly followed through on its commitment – political and financial – to boosting its domestic semiconductor production capacity. For a country that has long had a reputation for moving slowly on economic and market issues, that may signify a big and, to investors, welcome change. As Economy Minister Ken Saito said in announcing the Kumamoto Phase 2 project, “We learned from mistakes in the past, and I’m sure we have dazzled the rest of the world by the speed with which we have implemented.”
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
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