Blossoming Opportunities in Japan

Below is a transcript of this week’s video.

Hi, this is Ilona Vovk with Investment Strategy at Glenmede.

As spring unfolds, bringing with it the promise of renewal, so too does the Japanese equity market enter a season of emerging opportunities. The Nikkei 225 index, which measures the performance of a wide variety of Japanese stocks, recently eclipsed the 40,000 mark for the first time in its history. Japanese equity markets are now hitting new all-time highs for the first time since the fall of the Berlin Wall. This breakthrough comes several decades after some of the speculative excesses around Japan in the late 1980s. In contrast, Japan now appears to be on a more sustainable growth trajectory.

In fact, over the last 10 years, next twelve months earnings of Japanese companies have outgrown those of their larger international developed market region peer - Europe. Such growth in earnings has supported the growth in stock prices.

Another contributing factor of a resurgence of Japanese stocks have been the impactful reforms in corporate governance. This has been a multi-year process, initially kicked off by former prime minister Abe’s signature “three arrows” initiative. One of the fruits of that labor has been the introduction and enhancement of Japan’s Corporate Governance Code, which has played a pivotal role in promoting transparency, accountability, and efficiency among Japanese corporations. As a result, improving profitability metrics and changes to the culture of corporate cash hoarding have attracted investors to the compelling fundamentals of Japanese equities. It's important for companies to manage their cash wisely. Keeping too much cash on hand isn't efficient; they should have enough for stability but use extra funds to expand the business or return money to shareholders through dividends or buybacks. Holding excessive cash can be seen as poor management.

Now, given the rise in Japanese equities this year and the growing attention it has received, it would be justifiable for investors to question if all of this has already been priced in at this point. However, based on Glenmede Global Expected Returns model, the answer is still a no. Japanese equities trade at a notable discount to their European peers. The relative valuations between Japan and Europe currently sit in the 25th percentile, highlighting that Japanese firms still appear undervalued despite recent strong performance.

Lastly, when investing abroad, one also always needs to take into account the currency. And while it is hard to predict currencies since they follow such long-term swings in appreciation and decline, the yen appears quite cheap by historical standards. Currently, the yen is now trading two standard deviations away from its longer-term relationship to the dollar.

So to summarize,

• Much like the cherry blossoms now in season this spring, Japanese equity markets have been in full bloom to new all-time highs
• Earnings of Japanese corporations have been outpacing their European counterparts for the last decade and analysts expect this to continue this year
• Ongoing corporate reform efforts should continue to attract investor attention
• And valuations of Japanese companies and the yen itself suggest that investment opportunities remain
• Investors should maintain an overweight allocation to Japan in the international portion of their equity portfolios

And with that, thank you for listening! And please don’t hesitate to reach out with any questions.