Japan Attempts to Boost Growth and Valuations, But Demographic Drag May be Difficult to Overcome

The Nikkei’s strong 2023 gains, largely spurred on by buybacks, resilient GDP growth, and corporate reforms, have re-ignited interest in long underperforming Japanese equities. Chinese markets experienced outflows in the first half of the year, but it appears global investors are re-aligning inflows toward Japan.

However, the demographic spectre that has loomed over Japan for decades remains a key concern for the country’s labor force and overall economic activity. Japan’s fertility rate dropped to an all-time low in 2022 and government officials have continually struggled to devise a program that will improve those figures. Immigration is rising gradually, but attracting talent remains difficult.

Related ETF: iShares JPX-Nikkei 400 ETF, iShares MSCI Japan ETF (EWJ), iShares Currency Hedged MSCI Japan ETF (HEWJ)

A recent surge in Japan’s Nikkei 225 index has pointed to outsized gains for the country’s long-underperforming equities. Throughout more than 30 years between the start of 1991 and the end of 2022, the Nikkei had risen just 8.4%, generating an annualized return of less than 0.3% and massively trailing comparable global indices. In the year-to-date period, however, the Nikkei has gained about 29.1%, a shocking acceleration when compared to a multi-decade run of substandard returns.

The prolonged spate of weakness in share prices and muted profitability has left valuations of Japanese-listed firms relatively low, creating a potential bastion of value in a world where multiples remain extended in many places. Investors have applauded recent corporate reforms that have been explicitly aimed at raising those valuations. One of these key measures, directed at publicly-traded companies, will compel them to “comply or explain” if they are trading below a price-to-book (P/B) ratio of 1.0 — an indication a company may not be using its capital efficiently. This has been a prevalent issue in Japan’s financial sector, specifically, where just four Japanese banks out of a sample of 79, compiled by S&P Global Market Intelligence, had a P/B ratio above 1.0. Companies that do not expand this…