Why Japan could be best place to invest for next decade

A golden age for Japan’s stock market has been forecast as the country emerges from the shadows with some of the best global returns of the next decade.

In a report published today, US bank Jefferies said Japan’s “great shareholder return story” has begun and that investors will soon be prompted to ditch their underweight stance.

• Invest with ii: Buy International Shares | Most-traded US Stocks | Top UK Shares

It believes that Japan is entering a transformational decade of greater growth and investment, with changes in the policymaking around listings and corporate activity also beneficial.

The optimism follows three decades of economic stagnation after the bursting of Japan’s asset bubble. In this period, the country encountered deflation, low or negative growth and a series of financial crises, meaning GDP in 2022 was little changed from the $4 trillion of 1992 and down from $5.5 trillion in 1995.

Japan's equity market, which is worth $6 trillion, has trailed the rapid growth of Asian neighbours although the recent performance has been more encouraging after the Topix index this year rallied to a 30-year high.

• Portfolio diversification in action: see how it really works
• Stockwatch: a near-model growth stock, but for how long?
• Have we hit peak China pessimism?

Underpinning the optimism of Jefferies is the belief among its economists and equity analysts that Japan has finally exited deflation.

The "lost decades" have left many of Japan's industries extremely fragmented, meaning one of the first steps is consolidation and strategic choices about product portfolios.

Jefferies said: “All signs lead us to believe that it is ready for change. We believe Japan Inc is about to begin allocating capital to higher-return businesses (away from sub-scale ones) and generate much higher returns.”

The bank also notes a new consensus in Japan in favour of economic reform, helping to turn a shareholder 'unfriendly' place into a friendly one. This follows new listing requirements by the Tokyo Stock Exchange (TSE) relating to liquidity, corporate governance, profitability and returns with an aim to boost the capital efficiency of market constituents.

Companies that do not comply now have a firm deadline of March 2025, by which time they need to disclose action plans and progress or potentially face delisting.

• Nvidia and Scottish Mortgage hit by ban on chip sales to China
• Should you follow Warren Buffett into Japan?
• Fund Spotlight: former star trust now looks very cheap

Of the 3,800 TSE listings, Jefferies said that if the 43% trading below book value were to re-rate to a 1x price-to-book ratio they would see a market capitalisation weighted upside of 35%. It added that two of the most prominent Japanese companies, Toyota (NYSE:TM) and Sony (NYSE:SONY), have already taken action.

The bank said: “We expect significant corporate action over the next 12 to 18 months will catalyse investor attention and drive impressive returns.”

In addition, tightening by other central banks has caused positive price movements for the yen, which if sustained, could offer a big opportunity for investors in Japanese equities.

Its predictions for the rest of this decade include more institutional investor activity, with this deeper engagement having the potential to create sustained value. “We expect significantly more campaigns than in the past; higher quality of demands beyond buybacks and the size of target companies to become big caps.”

It is also backing Japan to produce more winners that will shine on the global stage. However, none will be from the automotive industry, which Jefferies predicts is likely to struggle to survive and will need to consolidate. The bank said: “Auto industry struggles this decade will be a case study - why speed is important when it comes to change.”