Over the past year the Nikkei index of Japanese shares has risen by 19 per cent.
Why do I hear only limited cheering?
Because the yen has fallen by 5 per cent against the dollar over that period and by around 10 per cent against sterling – OK, the latter figure is a bit exaggerated by sterling recovering from the exceptional Liz Truss and Kwasi Kwarteng period.
When UK-based investors go overseas, there is always a currency risk, unless the fund that you use hedges back to sterling. This can win and it can lose.
For most of the past 20 years, for instance, it has been a bad idea to be in a hedged US equity fund – the dollar has been a winner. Very often in the past, notably in the global financial crisis, it has been best to be in an unhedged Japanese equity fund (the yen rose strongly through 2008) but recently the yen has been awful.
There are two sides to investing in Japan and they do not balance each other. Japan has been trying to get rid of deflation for decades.
The economic policy they have adopted is an aggressive version of quantitative easing: the central bank buying large amounts of longer-dated bonds and keeping interest rates below zero. This seems to have brought back modest inflation, but real wages continue to lag, leaving the domestic economy weak.
The low interest rates encourage bond investors to borrow in yen and invest anywhere else (everyone else offers higher yields). This drives the yen lower.
In the medium term that should lead to an export boom, but even now that Covid no longer stands in the way of exports, few sectors are seeing a particularly vigorous rise in overseas demand, especially in higher value goods, which are less price sensitive.
Alongside the very loose monetary policy, the government has been progressing with changes to corporate governance, which started with 'Abenomics' a decade ago.
Companies have been encouraged to increase profitability and shareholder returns even if that slightly reduces market share and staff loyalty – the priorities of most Japanese companies in the past.
Also, the financial authorities’ attitude to corporate activism has radically changed. A decade ago the Japanese establishment would have circled the wagons around failing companies such as Toshiba, now it is sold to private equity without a murmur.
Today, Japanese equity still offers some of the world’s best companies at the world’s lowest valuations – particularly on price to book measures. A global equity fund holding some Japanese value stocks (such as their banks) provides balance against the weight of US technology stocks whose valuations have almost no support from book value.
Were inflation to prove more persistent in future, Japanese interest rates would rise, their banks will start making money from lending and the yen rise from its slump – potentially all happening together due to one surprise from the Bank of Japan.
