The Bank of Japan has tried to exit its ultra-loose monetary policy a number of times since it first introduced its Zero Interest Rate (ZIRP) policy in 1999. Unsuccessfully, as stubborn deflation has persisted, which explains policy makers’ cautious approach despite inflation currently exceeding the central bank’s 2% inflation target.
However, now the central bank has the best chance in decades of finally ending structural deflation as there are indications that wages are starting to rise1. At its last policy meeting the BoJ said it was easing its control of bond yields by taking a more flexible approach to targeting yields on 10-year government debt and dropping the strict 1.0% cap.2
While the bank increased its 2024 inflation forecast its prediction for 2025 CPI excluding fresh food and energy remains below the crucial 2% level.
Figure 1. The Bank of Japan first lowered its policy rate to zero in February 1999
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Source: Bank for International Settlements and Bank of Japan.
That signals policy makers will continue to tread carefully and refrain from prematurely tightening policy too quickly. So what does this mean for investors in Japanese equities?
The continued cautious stance should be positive for Japanese equities. Indeed, the day after the policy announcement saw the best day of performance for the Topix Index in over a year.
Given the confirmed gradual approach to normalisation and the outperformance of big banks, a better opportunity may now lie within non-bank financials and other domestic Japanese assets such as railways and real estate. Despite an extended period of QE followed by the pandemic, these remain attractively valued, but should now also benefit from domestic reflation.
Contrarian opportunity outside of Top Cap Value
An interesting contrarian opportunity has opened up within Japanese Value stocks. Just like in the US, Japanese market breadth has been narrow in 2023. Unlike the US though, performance was not driven by megacap tech stocks but a select number of Top Cap Value Stocks including banks and car makers.
One reason for the strength of Top Cap Value this year is their liquidity. Foreign investors returning to the Japanese market focused their buying on familiar, liquid, large-cap names.
Figure 2. Top and Mid-Cap Value Relative to the Value Style
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Source: Bloomberg.
But the stretch between Top Cap Value names and Mid Cap Value names has widened. Popular questions at the moment include “is there fuel left in the Japan Value tank” and “are you still finding enough buy opportunities?” The answers are yes and yes. But from a contrarian perspective the most interesting opportunity within Value could well lie outside of this year’s best performing Top Cap Value stocks. Mid Cap Value stocks generally remain relatively attractively valued vs. Japanese Top Cap Value stocks as well as relative to their overseas peers.
In addition the corporate governance revolution taking hold Japan is targeting companies with a need to improve capital efficiency and focus on their corporate value. This should naturally favour the Value style in Japan, but the opportunity for improvement is now probably larger in Mid Caps rather than the Top Caps, where corporate improvements should already have begun.
With contributions from Emily Badger, Portfolio Manager on the Japan CoreAlpha team, Man GLG.
1. https://www.bloomberg.com/news/articles/2023-11-06/japan-pay-growth-strengthens-for-first-time-in-four-months.
2. https://www.boj.or.jp/en/mopo/mpmdeci/ mpr_2023/mpr231031d.pdf
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