Fisher Investments Australia Reviews Japan’s Structural Headwinds

Japan’s long-running structural headwinds have contributed to the country’s infamous “lost decades” of sluggish economic growth and weak equity market gains relative to other nations. But what are these issues? And are they likely to keep weighing on returns?

Fisher Investments Australia’s review of Japan’s economic malaise has found many of the contributing factors are structural—the general regulatory and institutional framework businesses operate under. In Japan’s case, the country’s byzantine labour codes and its keiretsu system of corporate conglomeration, for example, create inefficiencies and barriers to competition. Those issues remain to this day—and have a history of chilling economic growth. However, they are also well known, suggesting cyclical factors and global economic trends are likely more significant to weigh in terms of an outlook for stocks. Let us explain.

Japan has strict labour laws, which makes hiring and firing difficult. This is a political choice with largely sociological consequences. Some prefer to maintain Japan’s “salaryman” corporate culture and lifetime employment (for some), which they see as underpinning social stability. From that perspective, the appeal is understandable. But from an investment standpoint, a rigid labour market leads to corporate sclerosis, as it prevents newer, more competitive firms from challenging stodgy, less productive incumbents. This lack of turnover also weighs on global competitiveness, in our view.

Japan’s keiretsu also contribute to stagnation. Keiretsu are business networks of allied companies—suppliers, manufacturers, distributors and sometimes even banks—locked together through cross-shareholdings. When Fisher Investments Australia reviews their business practices, they tend to become set in their ways, making them unresponsive to market changes—similar to competition-limiting monopolies.

It isn’t as if Japanese policymakers are unaware of these problems. But structural reforms are often difficult to implement. Entrenched interests—satisfied with the status quo—work to keep it that way, and the government has had limited success in pushing change.

The late Shinzo Abe—Japan’s longest-serving prime minister—famously tried to tackle structural reforms via his “third arrow” of economic policy prescriptions, aka Abenomics. He sought to unleash private sector entrepreneurship by raising Japanese innovation, productivity and competitiveness through streamlined regulations and other market-friendly reforms. Given Abe’s commanding parliamentary majority in his second term beginning in December 2012, he was arguably best positioned then to implement them, spurring high hopes.

Whilst Abe passed some liberalising measures, they weren’t as sweeping as many overseas observers believed they would be, in Fisher Investments Australia’s view. One of his signature achievements, for instance, was negotiating Japan’s entrance into the Trans-Pacific Partnership (TPP), a free trade agreement he thought would catalyse economic transformation. That didn’t play out as anticipated—notably, the US withdrew in 2017—though the pact (now known as the CPTPP) did enter force in December 2018. Note, some protections remained (e.g., for Japan’s rice farming industry)—a reminder of those vested interests. Meanwhile, though Abe enacted some measures to boost workplace flexibility, increasing full-time labour mobility fell by the wayside.

Recognising keiretsu’s limitations, third-arrow reforms also included measures to strengthen corporate governance. Institutions like the Tokyo Stock Exchange have since tried to make it easier to hold corporate boards more accountable to unlock shareholder value. This includes tightening listing requirements to discourage cross-shareholdings and pressing firms trading below book value to disclose how they plan to improve capital efficiency and returns. In response, shareholder activism, M&A and other ostensibly investor-friendly initiatives like dividend hikes and share buybacks have risen. But Fisher Investments Australia’s reviews of such actions find they remain mostly marginal. Whilst worth watching for certain industries and companies, they remain short of game changing for Japanese markets as a whole.

For global investors, though, such structural issues aren’t as problematic as they might sound, in our view. When Fisher Investments Australia reviews stocks’ principal drivers, cyclical factors swamp structural ones. Why? We think what matters most for markets is how earnings over the next 3 to 30 months (or so) fare against expectations. That is, stocks move mainly on surprise—what isn’t already priced in over the foreseeable future. Well-known problems stocks have dealt with for ages—like with structural reform—aren’t exactly shocking. They are generally part of the background.

Now, overhauling labour and corporate governance would probably be welcome and could generate long-term tailwinds. But it shouldn’t take precedence over near-term earnings drivers. It is just one factor worth considering when assessing Japan’s overall investment prospects, in Fisher Investments Australia’s view.

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