Many readers will already be familiar with the well-known quote from Hemmingway where one character asks another, ‘How did you go bankrupt?’ and receives the answer, ‘Two ways: gradually, then suddenly’.
The quote is perhaps better remembered than the novel it is extracted from because it seems to capture the paradox of change; small signals build up slowly, and then one day the process accelerates and the direction of travel appears with hindsight to have been obvious for some time.
Is the case for investing in Japanese equities today at a similar point?
Have the past few years – and even the entire decades since the bubble of the late 1980’s burst – seen the gradual accumulation of conditions favourable to Japan that could now suddenly galvanise this deep, rich market again? This article summarises the arguments recently presented by Alex Hart, Product Specialist at SMDAM, and Joe Bauernfreund, Fund Manager at Asset Value Investors, at a symposium hosted by SMDAM.
The traditional case for Japan
A series of factors have been lined-up in favour of the Japanese market for several years now. Both speakers emphasised this case in their presentations and highlighted the key features below:
1 - Under-valued
The Japanese market has tended to trade on very low valuations relative to other developed markets since the 1990s.
As Warren Buffet famously claimed in one of his much-quoted Chairman’s Letters, the starting price you pay for an investment will ultimately determine the investment performance, and accordingly we believe investors should pay attention to relative cheapness.
“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”
In terms of forward PE ratios, US equity valuations have recently come down to the 18.1x level from the heightened 20x’s levels seen previously. Meanwhile the Japanese market is languishing at 13.2x according to Bloomberg as at 14 March 2025. This would traditionally be seen as deep value territory, and it is important to point out that analyst EPS revisions are still in an upward trend suggesting the picture is in fact changing on the valuations front.
Going a little bit deeper, in terms of the wider TOPIX index, close to 50% of companies trade at below 1x price to book. This was a consequence of the collapse in asset values seen in the early 1990s and was further reinforced by the ‘cash hoarding’ behaviour of Japanese corporates that became endemic in the years that followed.
However, low valuations alone don’t make for a solid investment case. Whilst the Japanese market might previously have been seen as a potential value trap, as we explore further below there are now reasons to believe valuations are set to rise and that the market as a whole is now primed for the rebirth of its long-extinct dynamism.
2 - Under-researched
In combination with the high variety of companies trading at objectively low valuations, both speakers drew attention to the relative lack of research coverage.
According to Bloomberg as at 14 March 2025, the largest 100 companies in the S&P500 by market cap have on average 36 analysts covering them. Against this benchmark, even Japanese large-cap stocks included in the TOPIX 100 could be termed as ‘under-researched’. As the chart below shows, the average number of analysts covering the 100 largest Japanese companies is less than half that dedicated to covering their US counterparts.
As such, although as shown in the chart below this trend is more pronounced in the SMID cap space, this phenomenon is also at play in the large cap space and creates myriad opportunities for active management.
3 - Large and diverse investable universe
Lastly, with a listed universe of nearly 4,000 companies, Japan boasts a total investable universe significantly larger than almost all other developed markets. This effectively creates an ideal playing field for stock-picking, with indices and the passive approach failing to capture the opportunities presented by the high dispersion of returns across this deep, rich market.
Have the catalysts finally arrived?
Tenured observers of the Japanese market might not find the above case new or surprising. Indeed, the factors above have to varying degrees been present over the past decade.
What is new is that a triumvirate of catalysts have recently emerged that suggest the low valuations are set to be corrected and that an active approach can effectively capitalise on this.
1 - Corporate reforms
Launched in March 2023, the Tokyo Stock Exchange’s reforms to corporate governance now have the momentum and wide-spread acceptance required to bear fruit.
With companies across the market cap spectrum being proactively encouraged to introduce measures to raise P/B ratio, return excess cash to shareholders, increase CAPEX, and reduce crossholdings, a new atmosphere of efficiency and dynamism is returning to the market.
Championed by Tokyo Stock Exchange CEO Yamaji, SMDAM’s view is that this agenda has now put Japanese corporates onto an irreversible path towards converging with the norms of good corporate governance already embedded and priced in to other developed markets. The time is ripe for investors to capitalise on this trend, and both presenters outlined why they see this as a fundamental shift of gear in the outlook for Japanese equities.
2 - New generation of managers
Secondly, as we have covered in another recent article, Why is a fresh look at Japan today essential? , the decades that have passed since the bubble deflated in the early 1990s have proved sufficient to usher in a new generation of corporate leaders. This new generation is more willing to accept shareholder activism than their predecessors, and likewise much more open to the efficiency enhancing reforms that have previously been resisted. This provides an ideal entry-point for new investors who can take advantage of this ‘changing of the guard’ which could see valuations start to equalise between Japanese and comparable companies in other developed markets
3 - Deflation finally over
Finally on the macro side, the long-awaited virtuous cycle of rising wages and moderate inflation which would be needed to complete the ‘normalisation’ of the Japanese economy does seem to be gathering pace. As can be seen in the chart below, wage increases and core CPI have now established a consistent upwards trend, and SMDAM’s economists expect this to continue looking ahead.
If the hypothesis that Japan has at last escaped the deflationary trap that blighted the past two decades is correct, then it really is time for allocators to take a fresh look at this under-appreciated market.
Why should investors consider going active in Japan?
Drawing it all together, both speakers advocated that the scenario sketched above necessitates an active stance. With Japanese market indices containing comparatively large numbers of constituents, and with a high rate of dispersion expected between the winners and losers from this new environment, fundamental-driven, bottom-up stock picking seemed to both presenters to be the most appropriate method to play the market today. The positive factors discussed above will continue to play-out at varying rates across sectors and in terms of individual companies, and both speakers argued stock selection to be the essential means of generating alpha.
Gradually, and then suddenly, Japan is today enjoying all the pre-conditions to welcome in a new era of investing.
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Source: SMDAM
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General Disclaimer:This material is issued by Sumitomo Mitsui DS Asset Management (Hong Kong) Limited (“SMDAM(HK)”) for informational purposes only and has not been reviewed by the Securities and Futures Commission of Hong Kong (“SFC”) or any other regulatory authority. Persons who access or receive this material should determine whether it is permissible to access or receive it in the relevant jurisdiction without violating any applicable laws and regulations. The material may contain information related to funds which are authorized by the SFC that are available for public sale in Hong Kong. However, SFC authorization is not a recommendation or endorsement of the fund, nor does it guarantee the commercial merits of the fund or its performance. It does not mean the fund is suitable for all investors, nor is it an endorsement of its suitability for any particular investor or class of investors. The information contained in this material has been obtained from sources that are deemed to be reliable and is made available solely for informational purposes. SMDAM(HK) makes no representations or warranties as to the information and does not guarantee its accuracy, timeliness, completeness or usefulness. You are advised to exercise caution in relation to this material, and if you are in any doubt about the contents of this material, it is recommended that you should seek the advice of an independent professional. The written consent of SMDAM(HK) is required before it can be replicated or distributed to third parties or used for any other purpose, except as required by law or regulatory requirements. SMDAM(HK) and its affiliated entities accept no liability whatsoever for any consequences, whether direct or indirect that may arise from any third party’s use of information contained in this material. This material is not intended to serve as an invitation, offer, solicitation or recommendation for any investment strategy or the purchase or sale of securities, including shares or units of funds. Any views, analyses, perspectives expressed, and references to companies should not be construed as recommendations or endorsements by SMDAM(HK). All comments, opinions, data and forecasts in this material are based on the information available at the time of drafting, and are subject to change without prior notice in response to market and other conditions. The information provided does not constitute investment advice and should not be relied upon as such. This material may contain certain statements that may be deemed to be forward-looking statements. Please note that any such statements are not guarantees of future performance and actual results or developments may differ significantly from those projected. No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. This material does not have any regard to the specific investment objectives, financial situation and the particular needs of any specific person who may access or receive this material. Investment involves risk, including the possible loss of principal amount invested. The past performance information of the market, manager and investments and any forecasts on the economy, stock market, bond market or the economic trends of the markets are not indicative of future performance. Any investment decisions made by investors should not be solely based on this marketing material. Investors should refer to the fund’s Offering Documents, including the Product Key Facts Statement, in order to fully understand the associated risk factors. The value of an investment may go down or up. The final decision in relation to any investment in any stock, companies or markets referred to in this material should be made by you. If investment returns are not denominated in HKD or USD, US/HK dollar-based investors will be exposed to exchange rate fluctuations. The contents of this material are protected by copyright. Without SMDAM(HK)’s prior written consent, copying, reproduction or distribution of its contents in a hard copy and/or through the internet is strictly prohibited. Where the contents of this material have been translated into any language other than English and there is any inconsistency or ambiguity between the English version and the other version, the English version shall prevail. The above policies are subject to review and amendments by us from time to time. IMPORTANT: Please read this disclaimer carefully. By accepting this presentation, you acknowledge that you have read, understood, and agreed to be bound by the terms and conditions set forth herein. |
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