Japan’s new direction

This is an audio transcript of the Unhedged podcast episode: ‘Japan’s new direction’

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Ethan Wu
Japan is the world’s third-biggest economy, and this year its stock market, which usually is pretty unremarkable, has shown some really impressive signs of life. It’s up 20 per cent on the year. And that rally has been built on signs of really big change happening in corporate Japan. Today on the show, it’s crunch time for Japanese markets. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu here in the New York studio, joined from London by the FT’s other biggest Japan fan, Katie Martin.

Katie Martin
Hey, Ethan. How are you?

Ethan Wu
I’m well, thanks. I love talking about Japan. I feel like it’s like a bug that bit me and I wanna talk about it as much as our producers will let us talk about it. And I feel like you’re the same way. You wrote about this a lot, too.

Katie Martin
I’ve been in this business an embarrassingly long time, like writing about markets and talking to people about markets. And I’ve honestly gone for like literally decades without anyone mentioning Japanese stocks except to say, never buy Japanese stocks because they will always mess you up. There’s a private banker whom I talked to quite often, and he says that was like the first piece of advice that anyone gave him when he went to a trading floor was whatever you do, don’t buy Japan. (Laughter) It will never go your way. It will always let you down. You know, it’s been a terrible market to be in ever since the crash 30 years ago. But now suddenly I have fund managers cheering my ear off about it all the time. People are looking at Japan, they’re already invested in Japan. And suddenly this is one of the kind of go-to markets. And yeah, it’s quite unsettling, honestly.

Ethan Wu
Well, let’s back up maybe back to March, April, May, when the rally first started kicking off in earnest. What was the case for Japanese equities back then, Katie, towards the beginning of this year?

Katie Martin
The buy case. Well, it was a few things. It is partly the weekend, so that’s really good for exporters. People will argue about really how genuinely important this is for the performance of the stock market, but it certainly helps certain types of companies. But it’s also about this big focus that has taken root on a government level and on a stock market level around corporate governance and about making companies think differently, about actively working to push their share price higher. This might sound quite strange to Americans. For example, I get this, but it’s a big shift for corporate Japan to be told, right? You’ve got to push your price-to-book ratio higher, which means so your price-to-book ratio is does your share price indicate that your company is worth more than the sum total of all of your assets? So if you like liquidated everything tomorrow, just sold everything that you own as a business, would that be worth more or less than your share price? And the, what the push has been is to say you’ve got to push valuations higher, you’ve got to push multiples higher, you’ve got to bring in investors, whether that’s by bumping up your dividends, whether it’s by a shift in corporate strategy, whether it’s by buying back stocks or a combination of all of these things, just do what you can to push your share price higher. This is like a really big shift in the mindset, honestly.

Ethan Wu
Absolutely. It comes down to, you know, what model of capitalism is going to exist in Japan long term.

Katie Martin
You’re getting a bit deep and meaningful here, aren’t you, Ethan? I mean, come on.

Ethan Wu
There’s a great piece by the journalist and academic, Steven Vogel, called Japan’s Ambivalent Pursuit of Shareholder Capitalism. That kind of goes through how, you know, international finance tried to export a US- and maybe UK-style shareholder-first capitalist model to Japan. And the Japanese were kind of like, yeah, eh, we believe in stakeholder capitalism here in Japan. But that does seem to be changing, Katie. As you mentioned, you know, there was an initial push in the early 2010s during kind of the Abenomics era, you know, Shinzo Abe’s big push to get an official corporate code of conduct inducted and to just change the norms and expectations surrounding how companies are run, that if you make excess profit, you’re not just gonna put it in the bank and sit on it. You’re not gonna just buy your rival’s/friend’s shares and do nothing with it. You’re gonna take that cash and return it to the investors that have, you know, given you their capital to do business with.

Katie Martin
Yeah, and there’s a lot of other kind of really big factors at play here. One of them is inflation, which we should definitely talk about. But the other one is like demographics. And you can’t get much more fundamental than this, right? So obviously Japan has a very rapidly ageing population. One of the knock-on effects of that, investors constantly say to me is that suddenly workers are much more valued. And so if you are, you know, on the younger side and you are a worker and your company decides to rationalise and let people go, previously this would have been seen as just unacceptable. You’ve got to keep people in jobs. Now the mindset is much more, well, people can walk down the road and get another job somewhere else now because workers are in so much demand. So that completely shifts how companies think about staffing levels and rationalisation efforts and mergers and acquisitions and, you know, the prospect of being taken over by some overseas company — all of that stuff. It just gives you a slightly different slant really on how that all works.

Ethan Wu
So that was the case for Japan kinda coming into this year. And maybe I’d add to that list the fact that people were looking for a China alternative within Asia.

Katie Martin
Yeah, big time.

Ethan Wu
I think that was a big force. So people looking for a China alternative, the weak yen, this change in the way Japanese companies are run and also shifts in Japanese demography. So you saw a big run-up in the stock market, but since about maybe June or so, that’s stalled out and it’s been about flat. And I think it’s gotten people to ask the, you know, the question of why. And, you know, you framed this in a nice recent column, Katie, that, you know, it’s kind of crunch time for Japanese markets to sort of prove that this rally is for real and not just sort of a blip on the radar.

Katie Martin
Now, the third quarter of this year was pretty horrible for kind of all markets globally. It was like a real stinker, actually. Markets had a really bad summer, early autumn. And Japan’s not immune to this stuff, right? You know, if there is a pullback in the global economy or a pullback in investor sentiment, then you would expect Japan to suffer the same sort of things as everyone else. So the hope now is resting on a couple of things. One of them is that early next year, a massive program of encouraging ordinary Japanese people to invest in stocks is going to kick in. This is the new program. It’s kind of modelled on the British Isa scheme, for what it’s kind of, you know, tax-free or tax-efficient investment programs, and that’s gonna kick off next year. And so related to that, the authorities want to make sure that when they’re going to be trying to lure lots of ordinary Japanese people into the stock market, they don’t want this to be a disaster. (Laughs) They don’t want people to lose money horribly. They want markets to perform well. So they’re redoubling efforts to boost corporate performance effectively.

Ethan Wu
And I think you’ve seen pressure from Japanese authorities continue to increase. One of the key actors in applying that pressure has been the Japanese stock exchange. And I think, you know, most notably last week there was this great interview we had in the FT with the head of, you know, JPX which owns like the Tokyo Stock Exchange, the main Japanese exchange, and they’re doing effectively like a name and shame campaign for companies that don’t properly disclose required plans for corporate reform. It’s sort of like the equivalent if there was like a Nasdaq naughty list or like a footsie fortnightly fool or something like that of just companies that don’t behave well and like, you know, shaping up their balance sheet, returning cash to shareholders.

Katie Martin
Yeah, look, they’re not framing it exactly like that to be absolutely fair. But yes . . . (Laughter)

Ethan Wu
They should, actually.

Katie Martin
So really interesting interview with Hiromi Yamaji, who as you say, is chief executive of JPX, which owns the Osaka and Tokyo exchanges. Now, back in March, he said, you know, we — and it’s not obligatory — but we expect companies to show progress towards boosting their share price and improving corporate governance. It’s not an obligation. But this is sort of taken as a signal by the market back in March that, OK, they’re serious this time. They really do want corporate governance reform. And what he said to us the other day was that in like from January, the plan at least is to publish — drumroll — the list. So everyone’s been talking about the list. And this will be the list of companies that have indicated that have, you know, filled in a form somewhere to say we are making best efforts to improve the performance of our shares and to improve corporate governance. So they’re going to be publishing a list of companies that are compliant is not quite the work because, like I say, it’s not a rule, it’s a kind of aspiration. But they’re going to be publishing a list of companies that are showing intent to make progress towards this goal. And look, it’s not rocket science. You can match up this list of companies that are making best efforts, compare it to the full list of all the 3,000 or so companies that are listed on the main bits of these stock exchanges and figure out which ones are not on it. And so what investors are telling us is it’s gonna be a really big incentive to companies to really supercharge efforts if they’re not making them already, because a lot of not making them because, like I say, it’s not obligatory.

Ethan Wu
So I guess it’s kind of an exaggeration to call it the equivalent of the Nasdaq naughty list. It’s more like the Nasdaq nice list. And then they want to kind of infer who would be on the hypothetical modulus.

Katie Martin
Yes, that’s one way of looking at it.

Ethan Wu
But you know, I think that there’s a reason that they’re increasing this pressure, right. Which is that, you know, when the Tokyo Stock Exchange published these aspirational recommendations earlier this year, only about a third of companies actually, you know, less than a third have gotten on board with that program and actually started to publish or move toward publishing plans to shape up their finances. And so now this to me, I think this represents an escalation, even though incremental, on the behalf of the authorities, trying to kind of apply pressure in any way they can.

Katie Martin
Yeah, it is a gentle but meaningful escalation. And, you know, as the JPX chief executive was telling us, you know, this kind of nudge is important in Japanese culture and in Japanese markets.

Ethan Wu
Absolutely. This is something that comes up with anybody who does full-time investing in Japan based out of Japan is that it’s a culture where you want to kinda earn the respect of your peers and to be even like implicitly on a list of sort of, you know, disreputable or poor behaviour can imply kind of a lot of qualitative pressure. So to kind of add to our list of things that need to happen next for this Japan rally, right? We’ve mentioned retail investors in Japan need to get involved perhaps through this tax-free investment NISA account. Corporate reform needs to continue apace. And then lastly, I think this is one of the big swing factors global investors have to, at least on the margin, get on board with this bull case that’s been building for the better part of a year.

Katie Martin
Yeah. So now is the kind of crunch point. It’s time for people to put money where their mouths are if that’s the decision that they choose to take. But there’s no doubting the resolve of the authorities whether it will work or not. You know, longer term, nobody knows that. And Japan is about to say it’s not an island, but it is literally islands. (Laughter) But what I mean, it’s you know, it’s no, it’s not divorced from the global economy. You know, no one can control what happens next in terms of global growth and inflation. But certainly, the structural reform is there and nothing can happen without that. So that’s what the bulls are excited about.

Ethan Wu
And just to wrap up, Katie. I think this is really about capitalism. Again, you know, the explicit economic plan of the Kishida administration is to realise a new form of capitalism to double asset-based income. That’s their plan for the economy, to revitalise an economy that’s been a laggard for 20 or 30 years. Remains to be seen if it will work, of course. But I think, you know, if you wanted to make the case for global investors, I think you do kinda have to put it in those terms that there’s an attempt to reorient the fundamental model in a way that benefits both shareholders and, you know, hopefully everyday Japanese people, too.

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Katie Martin
This is profound stuff, Ethan.

Ethan Wu
Where’s Robert Armstrong when you need him? Alright, Katie, we’ll be back in a moment with Long/Short.

Welcome back. This is Long/Short, that part of the show where we go long a thing we love to love, short a thing we love to hate. Katie, I’m short this Citibank sandwich scandal employment lawsuit.

Katie Martin
Oh, that. I love this so much. (Laughter)

Ethan Wu
My God. Well, let’s explain what it is. So according to the Financial Times, basically right, Citi won an employment lawsuit where this guy who was just some analyst in like the regulatory compliance department or whatever. He expensed two sandwiches, two coffees and another drink allegedly for him and his partner. And then when confronted about it by the expenses department or his manager or whatever. He was like, yeah, I ate all these. Why are you questioning me? And it escalated into a whole fight over did he lie to the manager or whatever? And he got fired and he sued them and blah, blah, blah. The details are, you know, really just incredible. But I love how petty everyone is in the story, but I also hate it. Can we just be adults here? Right. Like, why did this have to escalate to management? Why did you have to get fired for this? It’s just ridiculous.

Katie Martin
So you want to purchase more sandwiches, is what you’re saying, on the company’s dime? (Ethan laughs)

Ethan Wu
I honestly, I do kind of agree with this guy’s principle, right? If it’s under the $100 limit, who cares if it goes to your spouse? Like, that’s, come on, this is an expense the company’s already allotted money for. What if I’m just really hungry?

Katie Martin
Listen. Don’t mess with the expense department, Ethan. This is like the number one rule of corporate life. You won’t win, and they will not back down.

Ethan Wu
That’s true. I know we have a lot of listeners at Citibank, and if you are one of them or at any other global bank and you have had one too many sandwiches on your expense account, please email me ethan.wu@ft.com. You will feel better having told me your confession. Katie, are you long something?

Katie Martin
I am very much long VC bros really hurting in the higher interest rate environment and taking it out on blog platforms. So I hope you have seen, if you haven’t, do check it out. Marc Andreessen from A16z (pronounced as A16 zed), I would call it, I think you’d call it A16z. But the big VC firm, big in crypto, big in a bunch of other things. He’s written quite a lengthy screed about technology and the manifold benefits that it brings to the world, and it really is worth a read. But there’s a whole section that particularly caught my eye, the section is called The Enemy.

Ethan Wu
Mm-hmm.

Katie Martin
So Marc Andreessen wants you to know we have enemies and they include risk management. (Laughter)

Ethan Wu
Dang.

Katie Martin
ESG and stakeholder capitalism to name just a few. It just says to me that as this interest rate cycle is turning, we’re going to see a lot of VC bros saying amusing things on the internet and I am here for it.

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Ethan Wu
Marc Andreessen, are you expensing illegal sandwiches? Let me know. Alright, Katie, thanks for being here. We’ll have you back next week. And listeners, we’ll be back in your feed on Thursday with another episode of Unhedged. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.