With the announcement that Japan’s prime minister Yoshihide Suga will step down, investors have found cause for optimism. That positivity stems from investor hopes that Suga’s successor will impose less restrictive COVID measures, thus allowing the Japanese economy to recover. On a fundamental basis, Japanese equities are well below their long-term average on a P/E basis relative to global equities, so there could be plenty of upside.
Optimism rises as Suga steps down
For most of 2021, Japanese equities have significantly lagged the rest of the world in terms of performance, having returned less than 10% by the end of August. Most developed market regions, meanwhile, have enjoyed returns of closer to 20% for the year.1
However, following the announcement by prime minister Yoshihide Suga that he would not run for re-election at the end of this month, Japanese equities surged higher, as shown in Figure 1. The rise set a new 30-year record high for the TOPIX index of Tokyo Stock Exchange Equities.
Figure 1: YTD Performance of MSCI Japan vs. Major Regional Equity Indices
This change in investor sentiment toward Japan has come about for a number of reasons. First, it is assumed that Suga’s successor will be less likely to impose the harsh restrictive and social distancing measures that have been enforced this year, especially given the government has now laid down a pledge that the economy will begin to re-open once a significant proportion of the population has been vaccinated.
Second, it is assumed that a new government may take a less austere approach when it comes to fiscal spending. Under Abe, Japan saw an unprecedented level of monetary stimulus coming from the Bank of Japan. However, two separate hikes in consumption tax somewhat hindered the effects of this stimulus. A new government might be willing to offer greater fiscal support to Japan’s fledgling economic recovery following the pandemic.
There is also speculation that Japan may now look to some form of modern monetary theory, or so-called helicopter money. An example could be making payments directly to families, as the US government has done, in hopes of increasing the impact that fiscal spending will have on consumers and their actions.
The fundamental case
Although this change in political landscape is only a catalyst, and does not have the necessary depth to sustain a strong rally in Japanese equities, fundamental data is also positive for Japan. Japanese equities were sitting well below long-term averages on a price-to-earnings basis relative to global equities, as shown in Figure 2. On this basis, there appears to be plenty of room to run for this rally going forward.
Figure 2: Historical Forward P/E of MSCI Japan (Relative to Global Equities)
1Source: Bloomberg Finance L.P., as of 31 August 2021.
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