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How Transformed Japanese Companies Became the Key Engine Driving Japan’s Stock Market Bull Run Despite Economic Sluggishness

In 2023, Japan’s nominal gross domestic product (GDP) was overtaken by Germany and fell out of the top three in the world. Moreover, in terms of real economic growth rate, Japan’s average annual real growth rate since the collapse of the bubble in 1992 is only 0.8%, which is a long-term sluggish state. In comparison, the Japanese stock market has experienced a huge change, first falling and then rising. When the world financial crisis broke out in 2008, the average Nikkei index fell to the bottom (7162 points). It did not turn upward until the implementation of “Abenomics” at the end of 2012. It has accelerated significantly in recent years. In the five years of the Reiwa era alone, the stock index has Achieve multiplication. This year it has soared, not only breaking through historical highs, but also once breaking through the 40,000-point mark.

Four major causes of Japan’s “bull market”

Currently, the Nikkei Average is 38,807 points (March 14, 2024), which is 2.7 times the closing price at the end of April 2014 (14,304 points). Due to the rise in stock prices and the influx of large amounts of capital, the total market capitalization of the Tokyo Stock Exchange has also risen rapidly and has returned to Asia’s first place. In the context of Japan’s long-term economic downturn, what factors are driving the stock market to continue to rise?

First of all, “Abenomics” plays an important role in stimulating the Japanese stock market. In April 2013, Japan launched a “different-dimensional” loose financial policy. As the central bank, the Bank of Japan also personally “stepped down” and purchased open-ended exchange funds (ETFs) and real estate investment trusts (REITs) on a large scale. Currently, the market value of ETFs held by the Bank of Japan is approximately 71 trillion yen (as of the end of February 2024), which is equivalent to 7% of the total market value of the Topix main board market. According to a survey by Nihon Keizai Shimbun, the central bank is already the top ten shareholder of 1,446 listed companies, and is even the largest shareholder of five companies including Tokyo Dome Corporation, Sapporo Holdings, Unitika, Nippon Sheet Glass and Aeon. Ultra-loose financial measures have created a “policy market” in which the stock market has risen, and the central bank’s massive capital injection into the stock market has directly pushed up stock prices.

Secondly, the “Buffett effect”, that is, the large influx of overseas funds, has become an important driving force for the Japanese stock market. At first, overseas investors mainly entered the Japanese capital market for the purpose of short-term profits. After the implementation of the Abe regime’s “three arrows” reform measures, foreign capital’s net purchases of Japanese stocks reached 16 trillion yen in 2013 and 2014, pushing the Nikkei stock index up by more than 7,000 points. Since then, profitable foreign capital has withdrawn on a large scale, with net sales reaching 12 trillion yen from 2015 to 2021. However, after Buffett invested in Japanese trading companies, the attitude of foreign investors quietly changed, shifting from short-term profits to long-term holdings. In 2023, Buffett announced that he would increase his holdings in the stocks of the five major trading companies, with an average shareholding of more than 8.5%. Affected by this, Wall Street bosses visited Japan one after another, and foreign capital continued to pour into the Japanese capital market. Data from the Tokyo Stock Exchange shows that in January this year alone, net purchases by foreign investors exceeded 2 trillion yen.

Third, corporate governance and the reform of the Tokyo Stock Exchange played an important role. The 2013 “Japan Recovery Strategy” proposed corporate governance reforms, requiring Japanese companies to incorporate capital efficiency and shareholder interests into their business strategies, and use return on equity (ROE) as an assessment indicator. In 2014, the Financial Services Agency issued the “Japan Due Diligence Code”, which proposed seven principles for institutional investors and their agent advisors to promote dialogue between shareholders and companies. In 2015, the Tokyo Stock Exchange promulgated the “Japanese Corporate Governance Code” to strengthen the responsibilities of the board of directors and introduce sustainable development issues and ESG (emphasis on the importance of ecological and environmental protection, fulfilling social responsibilities, and improving governance levels) elements. These reform measures have an important impact on adjusting the relationship between enterprises and shareholders and corporate strategies. In 2022, Topix will also reorganize its trading market sectors on a large scale with the purpose of promoting listed companies to focus on growth and liquidity. Starting in 2024, listed companies whose price-to-book ratio (PBR) is less than double will also be required to make rectifications.

Finally, the Small Investment Tax Exemption System (NISA) is becoming a “reservoir” for the stock market to continue to develop. In 2014, Japan launched the NISA system to encourage individual capital to enter the stock market. In 2024, the “Integrated NISA” system was launched, the tax exemption period was changed to unlimited, and the annual investment scale and total investment amount were expanded. Currently, the scale of Japanese household financial assets is 2,121 trillion yen (September 2023), of which stock holdings only account for 12%. Calculated based on the fact that 39% of American households hold stocks, this system can theoretically generate 572 trillion yen in new capital.

GDP does not equal the entire Japanese economy

In the era of economic globalization, GDP can no longer accurately measure the true economic status of a country. For example, Japan has more than 77,000 overseas companies, its overseas direct investment exceeds US$2 trillion, and its overseas net assets exceed US$3 trillion. It has been the world’s largest creditor country for 33 consecutive years. Obviously, GDP is only one component of Japan’s economy. Without examining its overseas economic factors, it will be difficult to reflect its overall true situation.

First of all, from a production capacity perspective, more than a quarter of Japan’s manufacturing industry is deployed in overseas markets. According to a survey by Japan’s Ministry of Economy, Trade and Industry, Japan’s overseas production ratio will be 25.8% in 2021, which is more than six times that of 1989 (4%). The number of manufacturing companies with overseas legal entities is 10,902, with a total number of employees of about 4.2 million, and sales exceeding 139 trillion yen. In addition, according to a survey by the Japan Bank for International Cooperation, Japan’s overseas production ratio will be 37% in 2023, which means that overseas production capacity will be as high as nearly 40%.

Secondly, from an investment perspective, Japan’s overseas investment mainly includes three parts: direct investment, securities investment and other investments. In 2021, the scale of Japan’s overseas investment will exceed one trillion yen, almost four times that of 1996. As of the end of 2022, Japan’s external portfolio investment has increased from 111 trillion yen in 1996 to 531 trillion yen, an increase of 3.8 times; direct investment has increased from 30 trillion yen to 274 trillion yen, an increase of 8 times. times. From the perspective of external net assets, it was 103 trillion yen in 1996 and 418.6 trillion yen in 2022, an increase of three times. Judging from these data (as shown in Figure 2), the Japanese economy shows significant globalization characteristics, and it is difficult to accurately estimate Japan’s economic strength based on GDP alone.

Third, the external current balance of payments structure also reflects the dramatic changes in Japan’s economic structure. Japan has transformed from a trading power to an investment power. Since the Great East Japan Earthquake in 2011, trade deficits have become commonplace. For example, the trade deficit in 2022 will reach 19.9 trillion yen, setting a historical record. On the contrary, the primary income and expenditure item, which is dominated by the surplus of external investment, has become the most important pillar of the current balance of payments surplus. In 2023, the figure will be 34.55 trillion yen, which is 6.15 trillion yen in 1996. 5.6 times. Because of this, the Japanese government’s attitude towards the exchange rate has also been reversed. At the beginning of 2022, affected by factors such as rising international energy prices, the Japanese yen suddenly depreciated against the US dollar. So far, the Japanese government is known to have intervened three times, using more than 9 trillion yen in funds. What is different from the past is that the Japanese government no longer adopts the traditional operation of “selling Japanese yen to buy U.S. dollars” but instead “selling U.S. dollars to buy Japanese yen”, which is to avoid a sharp depreciation of the Japanese yen. As Finance Minister Suzuki Shunichi said, “We don’t want the yen to depreciate because this is a bad yen depreciation.” In fact, in addition to worrying about rising import costs, the Japanese government is also afraid of forming a vicious cycle of “yen depreciation → rising costs → damage to the economic confidence of businesses and households”.

The depreciation of the yen has even affected Japan’s national power calculations. Japan’s nominal GDP in U.S. dollars in 2023 was US$4.21 trillion, surpassed by Germany’s US$4.46 trillion, falling to fourth place in the world. But in fact, Germany’s real economic growth rate in 2023 is -0.1%, while Japan’s is 1.9%. Obviously, Japan lost this time to the depreciation of the yen.

Transformed Japanese companies become key engines

Enterprise competitiveness has increasingly become the most important manifestation of a country’s economic strength. In recent years, the driving force for the strong growth of the U.S. economy has mainly come from technology giants such as “GAFAM” (i.e., the five major companies including Google, Apple, Facebook, Amazon, and Microsoft). In 2020, the market value of these five companies exceeded that of Tokyo at that time The total market capitalization of listed companies in the Securities Section. Today, Tesla in the field of electric vehicles and NVIDIA in the field of graphics processors have also joined them, turning from the “Five Golden Flowers” into the “Big Seven”.

It is true that it is difficult to find the above-mentioned “disruptive innovation” giants among Japanese companies, but this does not prevent Japanese companies from finding a suitable position for themselves in the global value chain system, and they have even established a strong sense of presence. Those Japanese companies that once frantically pursued “number one in market share” are quietly turning to the pursuit of unique advantages, and their strategic goals have changed from No. 1 to Only One. According to a survey by the Japanese Ministry of Economy, Trade and Industry, among more than 60% of the industrial categories in the global market in 2020, there are 220 Japanese companies, 99 American companies, 50 European companies, and 44 Chinese companies. Among them, 18 Japanese companies have sales of more than 1 trillion yen, as many as 33 companies in the United States, 25 European companies, and 28 Chinese companies. In a word, Japanese companies seem to be more like a pack of wolves than tigers.

In the 2024 “Global Innovation Rankings” just announced by Clarivate Analytics, the number of Japanese companies is the same as the previous year, continuing to maintain the absolute advantage of 38 companies selected. The second-ranked American company is 18 companies, which is higher than the previous year. One less family per year. Japanese companies have dominated this list for many consecutive years.

In recent years, Japanese companies have continued to accumulate profit surpluses and their profitability has also increased significantly. In 2022, the total regular profits of Japanese companies in all industries except the finance and insurance industry were 95.2 trillion yen, of which manufacturing companies were 34.6 trillion yen, both hitting record highs. The total profit surplus of Japanese companies is 554.7 trillion yen, which is almost as large as Japan’s GDP. The total profit surplus of manufacturing companies exceeds 200 trillion yen. From the perspective of profitability, the current regular profit margin of Japan’s entire industry has exceeded 6% for the first time, the average manufacturing level has exceeded 8%, and the figure for large manufacturing companies has exceeded 10%. This number has significantly exceeded the level during the bubble period (as shown in the figure) shown in 3). Moreover, having learned lessons from the bubble period, Japanese companies have also paid more attention to financial health. The average level of self-owned capital ratio in the entire industry (except finance and insurance) has reached 40.8%, and that of manufacturing companies has exceeded 49.8%.

In short, after more than 30 years of reforms since Heisei, Japan’s economic structure and business model have undergone profound changes. After globalization, Japan has shifted from a trade-based nation to an investment-based nation (recently it proposed a capital-based nation). If we observe Japan from the traditional GDP perspective, it will be difficult to reproduce the true full picture of its economy. Especially Japanese companies, as the real source of power supporting the formation of a long-term “bull market” in the Japanese stock market, their future strategies and action choices will become the key factors that determine the trend of Japan’s economy.

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