2023 Outlook on the Japanese Market

Hennessy Japan Fund Portfolio Manager Masa Takeda discusses his 2023 outlook for the Japanese markets and what could drive a rerating of valuation multiples.

March 2023
  • Masakazu Takeda
    Masakazu Takeda, CFA, CMA
    Portfolio Manager

Beau Barnett

Hi, everyone. My name is Beau Barnett, and I'm the Sales Director for Hennessy Funds. We appreciate you taking the time out of your busy schedules today to view a brief, but informative update from Masa Takeda, the lead Portfolio Manager of the Hennessy Japan Fund.

On this video, Masa is going to provide his market outlook on the Japanese market in 2023. With that, we look forward to speaking with you about the opportunity in Japan. And thanks again for viewing the video. 

What is your outlook for Japan in 2023? 

Masa Takeda

Now historically when the U.S. catches a cold, so does Japan. So from an economic standpoint, Japan may go through some tough times over the course of this year. However, we do believe that Japan, the valuations are quite attractive and they're undervalued relative to the fundamentals. And also, Japan might remain resilient because of its belated reopening in the economy-a sharp increase in the number of inbound tourists thanks to weak yen. The inbound tourists can contribute about 1% of Japan's GDP based on the assumption that there was about 30 million tourists at the peak in 2019. So if we can get back to that level, then with each person spending about $1500, the aggregate contribution to the economy can be about $40 billion+ U.S., which is about 1% of Japan's GDP, which is about $4 trillion+ U.S. dollars. So that is the bright spot for the Japanese economy in 2023. 

In terms of valuations, if the Japanese economy can remain resilient, there will be earnings growth and that should help increase the share prices of businesses. But in addition to that, we believe that valuations can also expand. If you look at the relationship between the market appreciation of the last several years versus corporate earnings performance from 2013 through today, the market roughly rose by 2.7x versus corporate earnings in terms of EPS rose by about 190%. So the earnings and market rose roughly in lockstep with each other. But there hasn't been any rerating.

The reason for Japan's PE multiple remaining so low, which is about 12x forward earnings, is because of perennially low return on equity relative to other regions such as the U.S. and Europe. Price to book is about 1.1x, PE multiple of 12x means return on equity of 9%. However, Japan has been working hard to improve its return on equity through various corporate governance reforms and initiatives, which was one of the main pillars of Abenomics.

So since around 2014, 2015, we introduced Stewardship Code and Corporate Governance School, where the institutional investors and companies can have constructive conversation in order to improve returns on capital efficiency as a whole. And I think for this reason, Japan is still in the midst of improving return on equity.

But going forward, we think that thanks to the structural trend towards better ROE, which is a relatively recent phenomenon, our role model is the UK. In the UK, corporate governance reforms started in the early nineties, so it has been a long time, whereas in Japan it's still a relatively new trend. And for that reason I think return on equity of Japan can still have a lot more room to improve. It should not stay at 9%, it will go past 10% and even to the low teens range. And if that is the case, then there's no reason why Japan should continue to trade at such a low multiple of 12x. 

So in addition to potential earnings growth in 2023, we do believe that there's scope for rerating of valuation multiples.