Would you please discuss the current Japanese economic environment?
We believe Japan’s economy is in a “sweet spot” with a business friendly, pro-inflationary government, benign currency, and a favorable interest rate environment.
Compared to the Federal Reserve, which has raised U.S. interest rates several times over the past year, the new Bank of Japan (BOJ) Governor Kazuo Ueda has made it clear that Japan is not ready to increase rates. With the BOJ determined to maintain its ultra-low monetary policy, we believe the interest rate environment will continue to be favorable for businesses and consumers.
As a function of the BOJ’s policy compared to the Fed’s rate hikes, the Japanese yen has depreciated. In an export-driven economy such as Japan’s, a weak currency is positive particularly for export-oriented companies.
Finally, Japan’s core consumer price index has been trending above 3% since last September, the highest in the last 40 years. If inflation remains at these levels, Japan could finally emerge from its long-standing deflationary environment.
What do you believe will support Japan’s economic growth over the coming months?
In addition to the continued BOJ’s accommodative monetary policy, we believe the following factors could support growth:
1. A recovery in inbound tourism. At the peak in 2019, there were 30 million tourists visiting Japan who spent an average of $1,200 per person, totaling approximately 1% of Japan’s GDP. It appears Japan is in the early stages of recovery and the pace of inbound tourists is accelerating, although we have yet to see Chinese tourists return. When they do, we believe the amount spent per tourist should be higher because the Japanese yen is weaker relative to 2019 levels.
2. Higher wages. The annual spring wage negotiation with labor unions resulted in an average wage increase of 3.7% on a year-over-year basis - the highest annual increase since 1993. We believe small companies will follow the larger companies’ lead with increased wages as well. This positive real wage growth is expected to drive an increase in consumer spending.
What are your thoughts regarding Berkshire Hathaway increased investment in Japan’s five major trading houses?
Berkshire Hathaway’s investment in Japan’s “sogo shosha,” including Fund holding Mitsubishi, has grown into a significant position in its publicly traded equity portfolio. Japanese stocks have also become one of the largest foreign exposures within its portfolio.
We have been long-term admirers of Warren Buffett, so it was a proud moment when we learned that he had invested in a stock we have owned in our Fund since 2007. Mitsubishi Corporation has been an attractive investment with a track record of compounding per share net asset value at a high single digit to over 10% compounded annual growth rate (CAGR) over the long term. Yet, it trades at value-stock-like multiples due to the perceived over-dependence on its natural commodity businesses and widely diversified business portfolios contributing to conglomerate discounts. We believe the company is often misunderstood by investors. We view Mitsubishi as an investment company rather than one focused on its natural resources business lines.
What are other catalysts for the Japanese stock market to maintain momentum?
We believe there are two additional catalysts to bolster growth. As an extension of the corporate governance reforms in Japan, the Tokyo Stock Exchange issued a statement urging publicly traded companies trading below 1x book value to make changes to encourage growth. It appears the management of these companies are taking this message seriously. There has been more awareness around how to improve their share prices through better capital efficiency and improved profitability. Given that approximately 50% of public companies are trading at less than 1x book value, there is substantial room for improvement.
Japan’s stable geopolitical environment provides another catalyst. Japan is often viewed as a safe haven in a geopolitically unstable world with companies choosing Japan as their country of choice to expand their global operations. For example, the chip maker Micron plans to expand its factory in Hiroshima, Japan, investing $5 billion. Japan’s stable political environment is also getting increased attention from institutional investors.
Would you please discuss the valuation of the overall Japanese market compared to that of the U.S.?
We believe Japanese equities look attractive relative to U.S. stocks. As of 4/30/23, the price to earnings
(P/E) of the Tokyo Stock Price Index (TOPIX) is trading at 13x 2024 earnings, about 25% lower than the S&P 500’s.
Historically, this discounted valuation was due to Japan’s lower return on equity (ROE) on average compared to the U.S.’s. However, ROEs have been gradually improving because of the corporate governance reforms put into place over the past several years that have encouraged companies to be more capital efficient and profitable.
While other factors should be considered, given valuation levels, it may be an excellent time to follow Warren Buffett’s lead and allocate to Japanese equities.
The top ten holdings for the Hennessy Japan Fund can be found on the fact sheet or here.