For over two decades, Japan endured an economic and financial market slump that rendered it the proverbial elephant in the room. It was there, but no one wanted to pay it any attention, much less commit assets. We don't necessarily count ourselves among that crowd, as we've had our sights — and our dollars — on Japan for some time. For those still seeing nothing more than a bear, we'd offer a different perspective.
No. 3 Economy (Still)
After an unprecedented 20 years of deflation, some may be surprised to know that Japan is still the No. 3 economy in the world, behind the US and China. Its gross domestic product is about one-third that of the US. Likewise, its population, at about 120 million, is roughly one-third the US population. Taken together, the two economies are essentially the same size on a per capita basis.
Notably, the majority of Japan's household wealth sits in cash — $9 trillion versus just $1 trillion in the national stock market. American households, meanwhile, hold about $18 trillion in US stock — a difference of 18 times for an economy and a population one-third the size of the US. Assuming a level of stock market participation proportionately similar to the US, household stock ownership in Japan could hypothetically rise from $1 trillion to $6 trillion — significant scope for the Japanese market to rise.
Japanese assets are also underowned by institutional investors, with the Japanese government and corporate pension plans each having less than 20% of their assets in the local stock market. We believe money will find its way into the equity market, particularly as more investors acknowledge the tremendous value that exists in Japan.
No. 1 Value?
While it's true that Japanese stocks have already enjoyed strong gains — up roughly 30% in local currency (USD) terms from their low in 2012 — we still see value. The unsettling market correction of late May only sweetened the value proposition, while doing nothing to alter the favorable fundamental backdrop: Many Japanese companies are the best in the world at what they do; years of deflation and a strengthening yen have driven many of these companies to pare costs to a minimum, resulting in remarkable efficiencies; and corporate balance sheets remain attractive.
Whereas US stocks have breached all-time highs more than once this year, Japan started its rally as the cheapest major market in the world and is still over 60% below its all-time high reached in 1989. Japan represented 14% of our benchmark index then, and it was the largest capitalization market in the world. Today, Japan's market cap has shrunk to about $2.5 trillion and roughly 4% of our benchmark. While this shrinking in importance has allowed some investors to conveniently ignore Japan, we have found tremendous opportunity there.
Hello Change, Bye-Bye Bear
We believe the catalyst for an enduring Japanese turnaround came in December with the landslide election that brought the Liberal Democratic Party into power and, with it, a mandate dubbed “Abenomics” aimed at resurrecting the animal spirits of the economy.
This coordinated and cohesive policy is focused on three arrows: 1) fiscal stimulus to kick-start economic activity; 2) monetary stimulus to further activity through a radical change in price expectations; and 3) growth strategies in the form of structural reform, aka “the golden arrow.” The first two arrows are temporary, effectively buying time for the crucial element of reform to drive self-sustaining growth. Implementation of these reforms will take time, and comes with a heightened risk of failure absent the political cover of a rebound in economic activity. But changes here, we believe, will set up the Japanese economy for a prolonged period of growth and an end to the bear dynamics that persisted for so many years.
In short, we see in Japan a combination of value and momentum that is rare in markets, catalyzed by a political change set on ending deflation and sparking growth. Combined with the fact that global investors are underallocated to Japanese stocks, there is more than ample scope for appreciation. Periodic market volatility is to be expected as conditions in Japan evolve; however, we believe the Japanese stock market could show strong relative performance for several years to come.
After a quarter-century bear market, there's an entire generation of investors who have learned to ignore the equity markets in Japan. We believe that is a mistake, and would submit that Japan is no longer a bear, or even the quiet elephant in the room, but the 800-pound gorilla demanding investor attention.
Dennis Stattman and Dan Chamby are co-portfolio managers of the BlackRock Global Allocation Fund.