September 22, 2023

Fundamentally: Japanese Stocks, Trying to Return to High Gear

As the administration of Prime Minister Shinzo Abe pushed to devalue the yen, investors gravitated toward long-forgotten Japanese exporters, which directly benefit from this policy. That’s because a weakening yen makes the price of Japanese-made products more competitive in the global marketplace.

Indeed, some of the best-performing Japanese stocks in this stretch were traditional, multinational industrial giants. Shares of Toyota Motor, for instance, returned nearly 115 percent from mid-November of last year to May 22.

Then in a flash, this strategy seemed to fall apart — or did it?

Concerns over the Bank of Japan’s commitment to so-called quantitative easing — coupled with fears that the Federal Reserve in the United States would soon end its own bond-buying program — helped push the country’s stocks into yet another correction. From its May 22 peak, the Nikkei 225 index of Japanese shares fell more than 20 percent by June 13. But then it came roaring back by more than 16 percent on more recent signs that the country’s economy was indeed nearing a turnaround.

The currency was also whipsawed. After exchange rates had sunk to a low of 103 yen to the dollar, the yen strengthened back to around 94 to the dollar before sliding again. At the end of the week, it stood at more than 99.

As the dust settles, Japanese equity funds are up more than 27 percent for the year. And, year to date, the yen has weakened more than 14 percent against the dollar.

This roller-coaster ride, though, has complicated matters for investors.

Should they go back to favoring shares of exporters, since the yen has been losing value again? Or should they ignore those companies and instead tilt toward businesses that can thrive under a strong yen, should the trend reverse once more? Or should they avoid Japanese stocks altogether?

Many market watchers say investors can sidestep these questions, at least for the moment. Instead, they can do what Japanese stock fund managers have done for years: find ways to invest in Japanese companies without necessarily betting on Japan’s economic growth.

For example, one of the top Japanese holdings in the Causeway International Value fund is the JGC Corporation, an engineering company.

“It’s one of our largest Japanese holdings but it has little do with Japan,” said Sarah H. Ketterer, co-manager of the fund, which beat more than 85 percent of its peers in the past year. Among other things, she said, the company builds liquefied natural-gas plants to help meet the growing demand for the fuel in Southeast Asia.

Over all, less than one-fifth of the company’s revenue comes from Japan.

Another alternative is to invest in companies that don’t necessarily require a strong economy, but that stand to benefit from demographic trends playing out in Japan.

Among the biggest holdings in the Matthews Japan fund, for instance, is JP-Holdings, which operates child-care centers.

In addition to advocating a weak yen to reinvigorate economic growth, Mr. Abe been calling for more women to enter the work force, including leadership posts in Japanese corporations. The country has long been plagued by an aging labor pool, in part because of a declining birthrate. Getting more women into the work force could help address the aging issue and bolster gross domestic product. To do that, though, the government acknowledges a need for more day care options nationwide.

“Companies have to boost investments in child care to facilitate moving young mothers into the work force,” said Taizo Ishida, lead manager of Matthews Japan. And JP-Holdings, one of the largest operators of child care centers in Japan, would surely stand to benefit, he said. Since the start of the year, the shares have more than tripled in value.

Strategists say investors should also look for those few Japanese companies that have shown a willingness to go against the grain.

For instance, during the years when the yen was strengthening, few exporters could gain global market share in the face of a strong currency.

One exception, though, was Unicharm, a maker of diapers. Yoko Sakai, an analyst at Harding Loevner who specializes in Japanese equities, said Unicharm could achieve this partly because it recognized early on that to sell in a cost-effective way to the developing world, it couldn’t rely on the same high-quality, high-priced diapers that Japanese customers demanded. It produced cheaper diapers, which proved quite popular in countries like Indonesia and Thailand, Ms. Sakai said.

Harding Loevner looked for the other kinds of nontraditional thinking from Japanese companies that are domestically oriented. “Whether the yen works for them or against them in a year or two,” she said, “we want companies that can find ways to improve.”

One such company, she said, is ABC-Mart, a shoe retailer in which Harding Loevner invests. ABC-Mart began as a wholesaler but decided to integrate vertically by owning its own retail stores. Then it began buying some shoe brands. “This company isn’t just taking share, it is disrupting the market and getting rid of the middleman,” she said.

WHEN will it be safe to start betting more directly on a Japanese rebound?

It’s hard to say, according to money managers. Skepticism about the future of the stock market is deeply rooted. “In Japan, people are conditioned to sell after a 20 percent rise in asset prices,” said M. Campbell Gunn, manager of the T. Rowe Price Japan fund.

And Ms. Sakai said, “If anybody tells you that they know what’s going to happen in Japan, they’re lying.”

At the very least, money managers say the recent correction is a reminder of just how far the Japanese stock market has to go before it really recovers.

Charles de Lardemelle, co-manager for the IVA International fund, points out that Japan, which has had a shrinking population and work force, hasn’t even begun to tackle the issue of immigration reform, which may also be required to turn around the population trend toward fewer workers. And at the corporate level, he said, there needs to be greater consolidation of companies with a greater focus on delivering more to shareholders.

“To have a real, sustainable long-term rally in Japan,” he said, “you have to see a lot of political changes that so far have not happened.”

Paul J. Lim is a senior editor at Money magazine. E-mail:

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