What do people really want governments to do? Look at it simplistically and there are two answers to this. Most of the time they want governments to create and operate an efficient infrastructure and then to stay out of the way, leaving them more or less unmolested to get on with the day-to-day business of life. But when things aren’t working, they demand something else: action and obvious leadership.
You could look at Brexit and at Donald Trump in this light (both are really calls for less passivity in the face of perceived crisis). You can look at the SNP-led Scottish government’s demand for another referendum in the same light (they haven’t done that well with the efficient infrastructure thing, so obvious aggressive leadership in the form of constitutional demands is a good cover).
However, it is also worth looking over to Japan. The country is ahead of the rest of us in the trying cycle of having a financial crisis, being paralysed by it and then demanding a strong leader to bring us out of it. Shinzo Abe, prime minister, is that strong leader. He is the first post-occupation leader to have returned to the role (he had a rather less strong stint as PM in 2006). He is doing what everyone wants him to do: he conducted a public “listening exercise” on social media (this might be where Nicola Sturgeon gets her ideas) to figure out what that was and focused his action firmly on the economy as a result.
The media has been behind him since day one (The Japan Times once announced that “Abe might be the world’s best leader”, Sheffield University’s Hugo Dobson reminds us) and his second consecutive landslide election in 2014 gave him a clear mandate to push forward his agenda for the revival of Japan.
And so we have what has become known as “Abenomics” – the relentless pursuit of inflation via loose monetary policy and public spending combined with the kinds of structural reforms that economists think drive long-term growth (these policies are known as the “three arrows”).
But Abe isn’t just offering Japan action, he is offering something rare and happy alongside it: political stability. He’s in for the long term. If you know anything about Japanese politics you will say that this can’t be so: the Liberal Democratic Party only allows leaders to serve two three-year terms. Never fear: the party has just changed its internal law to allow three terms, something that should keep him in power until 2021. If you don’t know anything about Japanese politics you will now say something along the lines of “Yes, but only if the LDP wins.” Again, you need not worry: in Japan the LDP always wins. Strong stable leadership it is.
So how is it going? Abe got some quick wins up front from Abenomics. He shovelled his preferred candidates into the Bank of Japan; he got the yen down by not far off 20% in six months (which is good for exporters); and he created enough in the way of “animal spirits” for the Nikkei 225 finally to make it back over 15,000 for the first time in five years.
Some softer data followed. But look at the economy today and it appears to be doing just fine. Once every three months the ministry of finance publishes what Jonathan Allum of SMBC Nikko calls “a vast wodge of corporate data” that allows him to have a “quick shufti under the bonnet of corporate Japan”. He has done just that – and proclaimed himself “satisfied” with the way it all looks.
Capital spending is slowly improving (this matters – capital spending drives productivity). Wages are finally on the up, rising at just under 1% a year at the moment. That might not sound like much but, trust me, relative to the past decade it is.
Corporate governance is much improved as well. Only ten years ago it was considered perfectly normal not to have outside directors on the basis that they didn’t understand the business and therefore had an annoying tendency to ask “stupid questions” (look up the Livedoor scandal). And only two years ago the co-founder of financial services group Orix Corp suggested that Japan should shut out the kind of short-termist “stupid shareholders” who demanded, among other crazy stuff, dividends. You don’t hear that kind of thing much any more: Japanese companies are buying back stock, and dividend yields are even rising!
The key thing from our point of view as investors is that sales and profits are all well above their levels of a year ago and Japanese corporate profits aren’t far off record highs. And this isn’t just about manufacturing companies making out from Abe’s weak yen – margins have been expanding rather faster in the non-manufacturing sector than the manufacturing sector.
You clearly can’t put all this good news down to Action Abe (there will always be a steady flow of analysts available to point out that things were going the right way long before he pitched up for his second round) and things aren’t exactly perfect either. But I wonder if they would have kept going the right way if prime ministers kept resigning; the country refused to discuss its immigration problem; and the Okinawa independence campaign had managed to convince more than 20 per cent of the population to lobby for a referendum. I’m rather guessing not.
Back to us as investors. Rising profits mean nothing to us if we have to overpay for them. The good news is that in Japan we really don’t. The Topix is still lower than 25 years ago. Forty per cent of Japanese firms trade on a price-to-book ratio of less than one, and the average forward price/earnings ratio for Japanese stocks is around 14.5 times
The strange thing about this is not just that Japan is cheap. But that it is so much cheaper than other developed markets. The average price/earnings ratio in Japan is still much where it was six years ago. But look to the US – where profits growth hasn’t been as fast – and you will see that forward p/e ratios have risen pretty aggressively during the same period. Why should US profits be worth so much more than Japanese profits to international investors?
If you agree that it seems a bit out of kilter you might want to look at some Japan funds on the market. In the investment trust sector, a good place to start is the Baillie Gifford Japan Trust (disclosure — I am on the board of Baillie’s other Japan trust, Shin Nippon and hold shares).
If you are interested in being in the real-value stocks in the Japanese market, you might also look to the Man GLG Japan Core Alpha fund, which is heavily invested in cheap banks, car manufacturers and steel. If there is no real reason for Japan to be cheap, it won’t stay cheap.
• This article was first published in the Financial Times