About the author: Patrick L. Springer is an institutional-equities business developer and Japan and Asia market specialist. He worked at Morgan Stanley in management roles for more than 20 years.
Japan just concluded a 34-year trek in the wilderness of deflation and ended its nearly 20-year negative interest-rate policy. The stock market has responded by achieving new all-time highs, last seen in 1989, rising 35% in the past year.
This might look like the top, but a closer look at Japan’s market suggests that the end is just the beginning for the world’s third-largest market. This year likely marks the beginning of a multiyear Japan market revival that will start a major new capital markets cycle. Japan’s companies are just beginning to celebrate a long-awaited return of pricing power supported by an enamoured global investor base looking for international ideas in a friendly market.
Investors should focus on two trends. First, new micro and macro forces are at work to make Japan a preferred non-U.S. destination for several years. With the U.S. dollar at 20-year highs, portfolio managers know that it is typically time to diversify and buy cheaper overseas markets, but where to go? Europe is cheap but challenging, and the I of India is what currently remains best of the emerging markets BRICS grouping. Exposure to Asia is important for global portfolios given it is 45% of global gross domestic product. Yet strategists say that we now live in a “multipolar world,” a euphemism for the highest level of geopolitical risks in the world in decades. This limits China investment allocations for now.
But Japan is a pre-eminent security partner for the U.S. Japan also is quickly becoming a key partner in U.S. reshoring strategies, especially as an alternative supplier of semiconductors and technology components. The reshoring trend is compounded by the yen’s weakness. At nearly 152 yen to the dollar, Japan’s currency is trading at the lowest ratio since 1990. That means Japan is also likely to regain market share that it lost over the past 20 years to China in automobile components, industrial products, and machinery. Status as a security partner matters to investors now, which will keep allocations to Japan higher for longer.
Second, Japan’s differentiated market structure may provide more alpha-idea opportunities than investors might expect from an older, developed economy. In the U.S., megacaps and the Magnificent Seven rule the world for investors—and for good reason, given their recent outperformance. The high level of exchange-traded fund penetration in the U.S. also favors large-caps over small- and medium-capitalisation stocks. But in Japan, the list of Japan’s largest companies remains unchanged: Excluding SoftBank, all were established pre-1960.
According to Abrdn Investments, 45% of Japan’s benchmark Topix Index of 2000 constituents have no analyst research coverage, compared with just 3% of the Russell 3000 universe for the U.S. As inflation sparks growth, earnings surprises and inflections of Japan’s under researched companies will lead to significantly higher alpha capture opportunities.
Additionally, the Japanese government and the Tokyo Stock Exchange have initiated important corporate-governance reforms, and 26% of all listed companies have submitted specific plans to improve their stock valuation. But many more companies have yet to respond, providing more opportunities for investors.
Sorting Japan’s nearly 3,900 stocks into market segments is revealing. Japanese mid-cap and small-cap stocks have lagged behind large-cap stocks by 40% and 60% year to date, respectively, and have lagged by 25% and 46% on a one-year basis.
Such underperformance by itself is one thing, but for the many investors who have never seen inflation, wage growth, and domestic sales gains in Japan, they may find a discovery universe of new stocks with interesting characteristics such as these:
Organo , a $2 billion market-cap water treatment company that has traded over $60 million a day on some days and counts Taiwan Semiconductor Manufacturing as one of its key growth customers.
Nakanishi , a $1.5 billion dental-equipment and precision-tools maker that grew sales 23% last year, sports a 2.5% yield and a 24% return on equity, and has 12% of its stock price in net cash.
Chugoku Marine Paints , a global top-three maker of marine paints that has a 20% global share and a 15% return on investment capital, sells at nearly 11 times earnings, and has a 2.6% dividend yield.
Overall, this analysis finds nearly 100 companies with a market cap above $1 billion with net cash equal to 20% or more of their stock price.
The bottom line is that Japan’s culture of innovation, combined with an end to deflation, is likely to produce a new wave of capitalisations. During the decades of deflation, corporates and consumers alike were incentivised to save more, spend less, and underinvest. But with nominal GDP growth now running at a whopping 5% and record wage growth, inflation incentivises new capital investment, stimulating a new investment-banking cycle of financing.
There are risks to this outlook. Double-digit market rallies can lead to pullbacks, and investors need to watch for threats to Japan’s inflation and currency levels and to its appetite for reform. But what’s most important for investors to realise about Japan is how much has changed there, amid a changing world.
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Multinationals like Starbucks and Marriott are taking a hard look at their Chinese operations—and tempering their outlooks.
For years, global companies showcased their Chinese operations as a source of robust growth. A burgeoning middle class, a stream of people moving to cities, and the creation of new services to cater to them—along with the promise of the further opening of the world’s second-largest economy—drew companies eager to tap into the action.
Then Covid hit, isolating China from much of the world. Chinese leader Xi Jinping tightened control of the economy, and U.S.-China relations hit a nadir. After decades of rapid growth, China’s economy is stuck in a rut, with increasing concerns about what will drive the next phase of its growth.
Though Chinese officials have acknowledged the sputtering economy, they have been reluctant to take more than incremental steps to reverse the trend. Making matters worse, government crackdowns on internet companies and measures to burst the country’s property bubble left households and businesses scarred.
Lowered Expectations
Now, multinational companies are taking a hard look at their Chinese operations and tempering their outlooks. Marriott International narrowed its global revenue per available room growth rate to 3% to 4%, citing continued weakness in China and expectations that demand could weaken further in the third quarter. Paris-based Kering , home to brands Gucci and Saint Laurent, posted a 22% decline in sales in the Asia-Pacific region, excluding Japan, in the first half amid weaker demand in Greater China, which includes Hong Kong and Macau.
Pricing pressure and deflation were common themes in quarterly results. Starbucks , which helped build a coffee culture in China over the past 25 years, described it as one of its most notable international challenges as it posted a 14% decline in sales from that business. As Chinese consumers reconsidered whether to spend money on Starbucks lattes, competitors such as Luckin Coffee increased pressure on the Seattle company. Starbucks executives said in their quarterly earnings call that “unprecedented store expansion” by rivals and a price war hurt profits and caused “significant disruptions” to the operating environment.
Executive anxiety extends beyond consumer companies. Elevator maker Otis Worldwide saw new-equipment orders in China fall by double digits in the second quarter, forcing it to cut its outlook for growth out of Asia. CEO Judy Marks told analysts on a quarterly earnings call that prices in China were down roughly 10% year over year, and she doesn’t see the pricing pressure abating. The company is turning to productivity improvements and cost cutting to blunt the hit.
Add in the uncertainty created by deteriorating U.S.-China relations, and many investors are steering clear. The iShares MSCI China exchange-traded fund has lost half its value since March 2021. Recovery attempts have been short-lived. undefined undefined And now some of those concerns are creeping into the U.S. market. “A decade ago China exposure [for a global company] was a way to add revenue growth to our portfolio,” says Margaret Vitrano, co-manager of large-cap growth strategies at ClearBridge Investments in New York. Today, she notes, “we now want to manage the risk of the China exposure.”
Vitrano expects improvement in 2025, but cautions it will be slow. Uncertainty over who will win the U.S. presidential election and the prospect of higher tariffs pose additional risks for global companies.
Behind the Malaise
For now, China is inching along at roughly 5% economic growth—down from a peak of 14% in 2007 and an average of about 8% in the 10 years before the pandemic. Chinese consumers hit by job losses and continued declines in property values are rethinking spending habits. Businesses worried about policy uncertainty are reluctant to invest and hire.
The trouble goes beyond frugal consumers. Xi is changing the economy’s growth model, relying less on the infrastructure and real estate market that fueled earlier growth. That means investing aggressively in manufacturing and exports as China looks to become more self-reliant and guard against geopolitical tensions.
The shift is hurting western multinationals, with deflationary forces amid burgeoning production capacity. “We have seen the investment community mark down expectations for these companies because they will have to change tack with lower-cost products and services,” says Joseph Quinlan, head of market strategy for the chief investment office at Merrill and Bank of America Private Bank.
Another challenge for multinationals outside of China is stiffened competition as Chinese companies innovate and expand—often with the backing of the government. Local rivals are upping the ante across sectors by building on their knowledge of local consumer preferences and the ability to produce higher-quality products.
Some global multinationals are having a hard time keeping up with homegrown innovation. Auto makers including General Motors have seen sales tumble and struggled to turn profitable as Chinese car shoppers increasingly opt for electric vehicles from BYD or NIO that are similar in price to internal-combustion-engine cars from foreign auto makers.
“China’s electric-vehicle makers have by leaps and bounds surpassed the capabilities of foreign brands who have a tie to the profit pool of internal combustible engines that they don’t want to disrupt,” says Christine Phillpotts, a fund manager for Ariel Investments’ emerging markets strategies.
Chinese companies are often faster than global rivals to market with new products or tweaks. “The cycle can be half of what it is for a global multinational with subsidiaries that need to check with headquarters, do an analysis, and then refresh,” Phillpotts says.
For many companies and investors, next year remains a question mark. Ashland CEO Guillermo Novo said in an August call with analysts that the chemical company was seeing a “big change” in China, with activity slowing and competition on pricing becoming more aggressive. The company, he said, was still trying to grasp the repercussions as it has created uncertainty in its 2025 outlook.
Sticking Around
Few companies are giving up. Executives at big global consumer and retail companies show no signs of reducing investment, with most still describing China as a long-term growth market, says Dana Telsey, CEO of Telsey Advisory Group.
Starbucks executives described the long-term opportunity as “significant,” with higher growth and margin opportunities in the future as China’s population continues to move from rural to suburban areas. But they also noted that their approach is evolving and they are in the early stages of exploring strategic partnerships.
Walmart sold its stake in August in Chinese e-commerce giant JD.com for $3.6 billion after an eight-year noncompete agreement expired. Analysts expect it to pump the money into its own Sam’s Club and Walmart China operation, which have benefited from the trend toward trading down in China.
“The story isn’t over for the global companies,” Phillpotts says. “It just means the effort and investment will be greater to compete.”
Corrections & Amplifications
Joseph Quinlan is head of market strategy for the chief investment office at Merrill and Bank of America Private Bank. An earlier version of this article incorrectly used his old title.