The US trade deal will further support improving economic fundamentals in Japan, which underpin our constructive equity positioning on the country. Recent political developments and volatility in the government bond market are unlikely to change our long-held view.Â
The striking of a better-than-feared trade deal with the US last week has removed a significant economic uncertainty for Japan, further bolstering the improving fundamentals of the country, and helping lift equities to near-record highs.
Driving this was some relief among investors that while the agreed 15% tariffs on Japanese imports is higher than the 10% rate that was in force while the countries negotiated, it is lower than the 25% levy President Donald Trump had threatened. Importantly, Japan’s automotive sector, a pillar of the country’s economy and biggest contributor to its $63bn trade surplus with the US, will incur the 15% rate and face no quotas on the volume of imports.
The greater clarity that comes with the deal is welcome. However, in recent days, fresh political uncertainties have emerged in Japan following the July 20 elections, when the ruling coalition led by Prime Minister Ishiba lost control of the upper house of parliament.
This was the third major election defeat after losing a majority of seats in the October 2024 lower house election and most recently in the Tokyo prefectural – metropolitan assembly – vote, which have led to calls within Ishiba’s own party for him to resign. Ishiba has said he has no plans to step down. However, mounting speculation over the Prime Minister’s potential successor and the prospect of them forming a coalition with any one of the resurgent opposition parties, which have been calling for more fiscal stimulus and lower taxes, has led to a fresh spike in long-dated Japanese government bond yields.
Japan has led the march higher this year in long-dated government bond yields among advanced economies amid a renewed and sharper focus by investors on fiscal stability.
Seeing through the politics
Such political machinations and volatility in the government bond market are to be closely watched, but they do not alter our long-held constructive view on the country. We were overweight Japan equities before the US trade deal was announced on July 22.
Indeed, the election results are unsurprising given a number of factors – including the current administration’s mishandling of inflation and political scandals – and view any change in leadership as immaterial to Japan’s sustainable economic growth and development over the medium term. Seen another way, any potential change in leadership – Ishiba was still in power at the time of writing although the situation is fluid – could even help to bring in new views and ideas on sustaining the country’s growth trajectory.
There are fundamental reasons why we remain constructive on the country.
First, Japan’s economy continues to gain momentum. Inflation is modestly stabilising above the Bank of Japan’s targeted 2% and is high enough to invigorate revenue and profit growth, while low unemployment and recent wage increases due to structural labour shortages have helped to boost spending among Gen Z and Millennials. Meanwhile the stronger Japanese currency versus year-ago levels has helped to curb imported cost inflation.
Second, thanks to the corporate governance and capital management reforms of the past several years, Japanese companies are becoming increasingly conscious of corporate value from a shareholder’s perspective. This has resulted in companies reducing their cash hoard and streamlining their cross-shareholdings, as well as making better use of their capital through growth investments, which are accretive for EPS growth over the medium to long term.
Third, despite potentially stronger growth, record corporate buybacks and ongoing shareholder-friendly corporate reforms, Japanese equities remain under-owned and relatively attractive compared to global peers. For instance, the aggregate forward price-to-earnings ratio represented by the MSCI Japan Index currently stands at 15.2 times compared to 19.0 times and 22.4 times for the MSCI ACWI and S&P 500 indexes, respectively.
Long-term growth opportunity
As we continue to closely watch the political situation and any fresh developments in the government bond market, we maintain a constructive outlook on Japan, choosing to look through these short-term moments of flux in a country that is in a new period of economic transition.
Clearly near-term risks remain, including volatile currency swings from monetary policy adjustments, which disrupted equity markets last August, but high-quality Japanese companies may be an attractive long-term investment opportunity.
By Joseph Amato, chief investment officer – equities at Neuberger
