“Anyone but Suga is good news”: T Rowe Price eyes further gains for Japanese equities as election approaches

japan election

Appetite for Japanese equities appears to be turning a corner after years of investors underweighting the region, with the country’s rapid roll-out of Covid-19 vaccinations and hopes over its upcoming election driving share prices higher in September.

Fund managers boosted their allocations to Japanese equities by an average of 11 percentage points in September to a net 1 per cent underweight, according to a monthly Bank of America survey. 

The newly-elected Liberal Democratic Party (LDP) leader, Fumio Kishida, is expected to become Japan’s next Prime Minister, after current Prime Minister Yoshihide Suga ends his term later this year.

Japanese stocks leapt in mid-September after Prime Minister Suga announced that he would not stand in the upcoming election. 

Both the Nikkei 225 and the broader Topix equity indices hit highs not seen in more than 30 years, since the collapse of Japan’s asset price in 1991.

“From our perspective, the markets are taking it as anyone but Suga is good news,” said Daniel Hurley, senior portfolio analyst and member of the Japan Equity investment team at T Rowe Price, speaking before the outcome of the LDP’s leadership race was decided.

“I think the reason why markets have moved so much in the past couple of weeks since Suga announced he wouldn't be standing for the LDP leadership, is the fact that Suga was struggling in the polls,” says Hurley. 

Prime Minister Yoshihide Suga suffered in approval ratings as voters complained about a lack of personal charisma, as well as his government’s slow response to coronavirus and the unpopular decision to hold the Olympic Games. 

Hurley continues: “Now the LDP will win, as expected before, but their majority will probably be even stronger than if Suga had been the leader standing for the election.” 

A strongly-supported new leader will be more likely to continue with structural reforms that begun under former Prime Minister Shinzo Abe, and potentially announce further fiscal stimulus, according to Hurley.

The frontrunner for next Prime Minister of Japan, Fumio Kishida, has said that Japan must keep expansionary fiscal and monetary policies in place, and pass "tens of trillions of yen" in economic stimulus to combat the coronavirus.

A Japanese election could be called as early as the end of October or early November, according to Hurley.

“They’ll have to call an election by the end of November,” says Hurley. “But there's speculation that because the new leader will have a honeymoon period, they may even call the election earlier than that to take advantage of strong polling numbers.”

Japanese stocks were already gaining momentum before Suga’s departure was announced, since major headwinds including the Tokyo Olympic Games and the slow start to Japan’s vaccination drive were receding from view, according to Hurley.

The Olympics weighed on markets since it led the government to increase coronavirus restrictions in the early part of the year, at the same time as other global economies were opening up. 

Although it was later than other major economies to begin vaccinating its population, Japan has been administering jabs at a startling rate of more than one million per day in September.

“Even before Suga announced he wasn't standing, markets had really started to appreciate just how quickly the vaccine rollout was going ahead,” says Hurley. 

“We think that this is going to see Japan meaningfully catch up in terms of market performance, as the market appreciates just how quickly this rollout has been going ahead,” says Hurley, noting that Japan’s vaccination programme overtook the US in September.

Foreign investors are now lessening their underweight positions toward Japanese markets for the first time in years, notes Hurley. Major asset managers including JPMorgan, Baillie Gifford, and BNP Paribas Asset Management are among the investors that have become more positive on Japan ahead of the election.

He explains: “The longer-term aversion to Japan for foreign investors, and really their frustration there has been on the corporate governance side of things.”

Japan’s corporate governance code was revised earlier this year to carry on reforms promised by former PM Abe, with companies urged to hire independent board directors, improve gender and ethnic diversity, and improve climate risk disclosure.

There has already been a “massive improvement” in corporate governance standards over the last 15 years, with many more companies hiring independent board members.

Hurley sees the potential for foreign investors adopting higher long-term allocations to Japanese markets as corporate governance improves.

T Rowe Price is voting against boards with no female representation in Japan, and engaging with companies to improve their ESG disclosures.

Nevertheless, Hurley says it will take many years for reforms to bed in due to Japan’s conservative culture.

“This is definitely a trend we're thinking about as an opportunity over the next three, five, even 10 years, rather than something that investors should look out immediately.”

He says an “interesting point” has been reached with activist hedge funds successfully targeting Japanese companies, which he believes will continue to grow. 

“They had always targeted Japan in the past, but now where they have independent board members, they can lobby and vote against them,” says Hurley.

Last year, SoftBank announced the biggest share buyback in corporate Japan's history, shortly after renowned activist outfit Elliott Management Corp took a USD3 billion stake in the company. 

Hurley notes that improvements to corporate governance in the country is making it easier for investors to engage with boards to change the way capital is allocated, including proposing share buybacks to improve returns and attract investors.

“One of the things that has frustrated foreign investors for some time in Japan has been the poor returns you get from the companies, and how they prefer to almost hoard cash,” says Hurley.

“Some companies that we see in Japan have got 40 per cent of their balance sheet just sitting in cash, idly earning 0 per cent at the Bank of Japan.”

In addition to corporate governance standards improving, Japan is still cheap in Price/Earnings ratios, compared to Europe and the US. 

Hurley sees earnings as likely to pick up since Japan is an incredibly open and cyclical market, which will likely benefit as the global economy rebounds.

Suga’s push to encourage digital innovation in Japan has led to some interesting investment opportunities, with T Rowe Price currently exploring the digital wealth management sector.

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