What are the reasons for this, and where do the opportunities lie? And is now a good time for UK investors to consider Japan?
There are fundamental differences in Japan’s economy to explain why inflation is not the problem in Japan as it is in many other parts of the world.
Firstly, underlying consumption has stood still in the past decade or so.
Secondly, there has been virtually no wage growth in Japan.
Over the past 30 years, wages grew by just 3 per cent – much lower than the OECD average – while the latest data shows that Japan’s base wage grew by less than 1 per cent.
Generally speaking, without rising household income, you cannot expect inflation to accelerate.
Although Japan’s CPI has picked up recently, this is mainly due to the reopening of the economy after the state of emergency earlier this year. This pick-up is being driven by cost-push effects, rather than increased demand.
Another key difference in Japan is the extremely conservative attitude of householders.
We believe that inflation will stay relatively mild in Japan and interest rates should remain low.More than half of Japan’s household assets are held in bank deposits, with only small amounts in the stock market.
As a result, the 'wealth effect' in Japan has been subdued – the majority of Japanese people have not benefited from the surging stock market post-Covid, another reason inflation has been quite mild.
On the bright side, this conservative mindset means Japanese companies have large cash reserves on their balance sheet.
Their attitude towards shareholder returns has improved significantly in the past decade, as share buybacks hit a record high level in 2021 and we expect more to come.
Notably over the past few months, a number of companies announced increased dividend payout ratios as well as share buybacks, with the intention of protecting shareholder returns in this volatile market.
We believe that inflation will stay relatively mild in Japan and interest rates should remain low.
We expect both monetary and fiscal policies to continue to be supportive in the foreseeable future.
The effect of a weaker yen on Japan's inflation
Energy CPI in Japan has risen by just 45 per cent since the beginning of 1996, whereas in the US and Europe it is up by more than 150 per cent.
The price of crude oil has risen by more than 1,000 per cent from trough to peak while energy prices in Japan have risen by just 30 per cent.
Since energy is only 7 per cent of Japan’s overall CPI budget, even if the crude oil price doubles in yen terms, the impact on CPI is a negligible 0.4 per cent.
Similarly, if we compare Japan’s food CPI with global food prices, there is absolutely no correlation. The impact from a weaker yen on inflation in Japan is very, very limited.
We would argue that a weaker yen actually works in favour of certain companies.
The country will soon reopen to foreign tourists, which should benefit domestic consumer services and staples companies.
Meanwhile, Japanese companies that compete on the global stage but have most of their operations in Japan should become more cost-competitive.
Can companies that compete on a global scale weather rising global inflation?
Japanese companies have learnt a key lesson from the past 25 years.
Because of Japan’s stagnant economy, they have learnt to adapt their business models and strategies to grow regardless of the macro environment.
As a result, the best companies do not base their growth on inflation or economic growth, they instead launch new services and innovative products.
The companies that compete on the global stage usually have high gross margins. They do not pass through costs to their customers in a direct way – they will launch value-added products and charge more so that they can protect their margin.
Opportunities in under-penetrated industries could offset growth concerns
We are not seeking to capture Japan’s GDP growth (or lack thereof) – just a slice of this growing profit pool.
And we have found plenty of opportunities (hidden gems) in Japan. There are a large number of global companies with dominant market share in industries with secular growth, such as online recruitment services, factory automation, medical recruitment and premium consumer goods.
We also like leading companies in under-penetrated service industries, run by capable management who are highly motivated and think outside of the box.
They are taking calculated risks to displace outdated business practices and complacent incumbents.
In Japan, services like e-commerce, cashless payments and cloud services are still under-penetrated, whereas they are already proven business models in other developed markets.
Japanese firms are slowly changing their attitude towards digitalisation, which implies huge potential for these types of companies.
They are not only growing at a relatively high pace, but they also have high growth visibility due to the lack of competition in Japan.
Why consider Japan?
Investors focused on the macro outlook often ask, 'Why should I bother with Japan?'
Japan’s corporate profits have continued to grow to record-high levels, driven by global expansion, innovative products and the development of new technologies.
Corporate restructurings and an increasing focus on return on invested capital have also contributed to higher profits; and in each sector, the gap between the winners and the losers is widening.
As a result, we believe that an active and bottom-up investment strategy would work well in the Japan market.
Sophia Li is a portfolio manager at FSSA Investment Managers, part of First Sentier Investors
