© Reuters. FILE PHOTO: Japanese national flag is hoisted atop the headquarters of Bank of Japan in Tokyo, Japan September 20, 2023. REUTERS/Issei Kato/File Photo
By Naomi Rovnick and Kevin Buckland
LONDON/TOKYO (Reuters) – Global inflationary forces are finally seeping into Japan’s economy after decades of falling prices, forcing investors to radically rethink their Japan bets as the Bank of Japan considers a major policy shift.
International investors, who have long favoured stocks benefiting from Japan’s ageing population or a weakening yen, are tearing up their playbooks to focus on expected higher interest rates, more generous dividends and a revival in consumer spending.
The policy switch has been slow in coming but could herald an entirely new way of investing in Japan if a predicted long-term inflation rate of 2% in 2024 really happens.
Japanese shoppers who no longer expect prices to keep falling may make big purchases. If the BOJ pulls interest rates above zero for the first time in years, banks’ lending margins could rise.
Japanese stock markets have already rallied to around their highest since 1990, with consumer and financial stocks outperforming domestic indexes. On the downside, inflation creates a bleak outlook for Japanese government bonds.
“Interest rate policy is undergoing a historic change,” said Shigeka Koda, chief executive of the $500 million Singapore-based hedge fund Four Seasons Asia Investment.
“Something new is in the offing.”
BANKS UPSTAGE CREMATORIA AND CAKE-MAKING ROBOTS
Japan’s ageing demographic has made a Japanese crematorium company one of the top picks for foreign investors, with its shares up almost 700% in five years.
Koda’s top positions have included the crematorium operator – Kosaido Holdings – as well as Rheon Automatic Machinery, which sells cake-making robots to help food manufacturers deal with a shrinking workforce.
But in August, for the first time in the 17-year history of his fund, Koda picked a Japanese bank, Kyushu Financial, as his largest position, because he believes Japanese interest rates will rise.
Steve Donzé, deputy head of investment at Pictet Asset Management in Tokyo, said he had also been buying Japanese bank stocks.
For Junichi Inoue, head of Japanese equities at Janus Henderson, consumer businesses with the pricing power to increase revenues and profits by passing higher energy and food costs on to customers were the focus.
“I do like convenience stores,” he said. “Margins have really been going up, earnings have been good – positively surprising.”
NEW DYNAMIC?
Japanese wages, adjusted for inflation, fell in the 18 consecutive months to September. But big employers are expected to agree bumper pay hikes in the spring.
“You really need to see services inflation come through in order for inflation to be sticky, and that’s driven by wages,” said, James Halse, portfolio manager at Platinum Asset Management in Sydney.
Data out on Friday is expected to show core consumer prices accelerated again in October, staying above target for a 19th straight month.
Global fund managers are the most positive on Japanese stocks since March 2018, a Bank of America survey published on Nov. 14 showed. And Warren Buffett is buying.
Japan’s index, one of the key indexes on the Tokyo Stock Exchange, has jumped 26% this year, helped by corporate governance reforms.
David Hogarty, senior portfolio manager at Dublin-based KBI Global Investors, said he had turned positive on Japan partly because higher inflation would pressure companies to boost dividend payouts.
“Typically, if you increase your dividend in inflationary times, people like that,” he said, noting Japan currently has the highest dividend growth globally at about 20% year-on-year.
BOND PAIN
Japanese inflation means bond investors could suffer. Rising inflation reduces the appeal of fixed interest-paying bonds.
The BOJ has also long supported the bond market by buying government debt to cap yields and suppress domestic borrowing costs. But investors are cautious about this so-called yield curve control policy ending as the BOJ is forced to tighten monetary policy.
Inflation “probably isn’t transitory” for Japan because it had not been in the United States or Europe, said Jon Day, global bond portfolio manager at Newton Investment Management.
“And of course the bond market isn’t fully priced for it.” The five-year JGB yield is around 0.35%. Even a long-term inflation rate of 1% in Japan would make that a “terrible return,” Day said.
U.S. Treasuries are facing a third year of hefty price falls after aggressive Federal Reserve tightening took rates to 5.25%-5.5%. At minus 0.1%, the BOJ is the only major central bank with negative rates.
Grégoire Pesques, CIO for fixed income at Europe’s largest fund manager Amundi, said he holds a short position on the 10-year JGB as he expects yields to rise from around 0.8% currently, as bond prices fall.
Rising yields could finally lift a battered yen.
The yen, which surged to 133 per dollar in December 2022 when the BOJ hinted it would review yield-curve control, dropped as low as 151.92 last week.
“The direction of travel is clear and away from unsustainably easy (monetary) policy,” Pictet’s Donzé said, forecasting “a stronger currency as we move into 2024.”
