Reflecting on reflections from Japan
Reflecting on reflections from Japan
Dan Carter considers the challenges Japanese equites face and outlines the approach he has taken to overcoming these as an investor in the asset class.
Last month, the article which grabbed our attention the most came not from a financial journal or even the Japanese press, but from the BBC. In his swansong essay (linked below), the Corporation’s Tokyo correspondent Rupert Wingfield-Hayes looks back at his time in Japan and paints a portrait of the country as he has come to understand it1.
The article is as unflattering as it is accurate, describing many of the challenges which we have faced as investors. The journalist outlines five major pathologies from which he sees Japan suffering – affecting property, wages, efficiency, public finances and politics – all of which are expressions of Japan’s mother characteristic: its aging and declining population. This piece aims not to debunk the BBC article – we agree with much of it – but to outline the approaches we have taken such that our clients might benefit from the realities which it describes. Let’s meet the issues one by one:
The article is as unflattering as it is accurate, describing many of the challenges which we have faced as investors. The journalist outlines five major pathologies from which he sees Japan suffering – affecting property, wages, efficiency, public finances and politics – all of which are expressions of Japan’s mother characteristic: its aging and declining population. This piece aims not to debunk the BBC article – we agree with much of it – but to outline the approaches we have taken such that our clients might benefit from the realities which it describes. Let’s meet the issues one by one:
1. Rural Japan is dying off, and property is a depreciating asset
This is indisputable. We are inured to the steady stream of articles detailing how regional Japan, outside of the major metropolises, is being hollowed out. Younger people have moved to bigger cities, turning rural communities into enclaves of the elderly. The increasingly desperate local attempts to arrest the decline, or at least to palliate the survivors, make for mawkish copy but they emphasise a point. Nowhere more than Nagoro, the village made famous by its knitted avatars of absent residents2.
Increasingly, homes in Japan lay empty. Nomura Research Institute estimates that 11 million residential properties are unoccupied – more than the entire housing stock of Australia.3 Depopulation combines with Japan’s culture of scrap and build in a way that is toxic to property prices. Even in urban areas where land values are more stable, housing is seen as a depreciating asset, not as a store of wealth.
We deal with this reality by combining common sense with contrarianism, a recipe which will feature repeatedly. From a strategy perspective, we tend to avoid regional banks, of which there is a worryingly large choice – more then seventy are listed on the Tokyo Stock Exchange. Some argue that their market value is even lower than their intrinsic worth, and others have fought to change management in the hope of attracting a fairer price. They might be right, but with such a paucity of growth opportunities, bloated costs and pressure to continue to prop-up struggling local businesses, we choose to look elsewhere. That is common sense.
In contrast, Katitas – which buys, renovates and sells unoccupied property – appears to be swimming against the tide. For this company, the availability of empty homes is a boon. Transactions, often with the estates of diseased owners, are simple. The properties are cheap. Of course, Katitas must ensure there is enough life in the locality to provide demand; we would be worried if they opened a branch in Nagoro. Management has a great record of doing just that – if consensus estimates for the current year are right, the business will have doubled operating profits over the last half decade.4 A keenly priced Katitas home is perfect for those who expect property prices to erode and for those on low and stagnant incomes. This brings us to our next issue.
Increasingly, homes in Japan lay empty. Nomura Research Institute estimates that 11 million residential properties are unoccupied – more than the entire housing stock of Australia.3 Depopulation combines with Japan’s culture of scrap and build in a way that is toxic to property prices. Even in urban areas where land values are more stable, housing is seen as a depreciating asset, not as a store of wealth.
We deal with this reality by combining common sense with contrarianism, a recipe which will feature repeatedly. From a strategy perspective, we tend to avoid regional banks, of which there is a worryingly large choice – more then seventy are listed on the Tokyo Stock Exchange. Some argue that their market value is even lower than their intrinsic worth, and others have fought to change management in the hope of attracting a fairer price. They might be right, but with such a paucity of growth opportunities, bloated costs and pressure to continue to prop-up struggling local businesses, we choose to look elsewhere. That is common sense.
In contrast, Katitas – which buys, renovates and sells unoccupied property – appears to be swimming against the tide. For this company, the availability of empty homes is a boon. Transactions, often with the estates of diseased owners, are simple. The properties are cheap. Of course, Katitas must ensure there is enough life in the locality to provide demand; we would be worried if they opened a branch in Nagoro. Management has a great record of doing just that – if consensus estimates for the current year are right, the business will have doubled operating profits over the last half decade.4 A keenly priced Katitas home is perfect for those who expect property prices to erode and for those on low and stagnant incomes. This brings us to our next issue.
2. In Japan, wage growth is meagre
True. For most people, pay rises have been almost entirely a function of their own aging as the chart below shows.5 The annual uplift to wages awarded for the accumulation of experience has massively overwhelmed any underlying inflation – or “base up” as it is termed in Japan. A weak Yen has trashed Japanese pay in foreign currency terms. Once an expensive place to hire, Japanese workers are now cheap. The minimum wage in Tokyo – the highest in all the land – is only ¥1072, or £6.70 per hour.6
Source: Bloomberg, 30/01/2023
Underlying wage growth in Japan has been minimal
Lacklustre wage growth and an ever-older population is kryptonite for consumption. Tax hike pre-buying and natural disasters have caused ups and downs respectively, but overall real consumption has gone nowhere in Japan for the last twenty years.7 For this reason, we tend to avoid businesses most reliant upon consumer spending. No retailers, food or leisure companies feature in the Jupiter Japan strategies. Once again, we consider this to be common sense.
Source: Bloomberg, 30/01/2023
Real consumption is only marginally higher than it was two decades ago
There is some hope that this might be changing. Because of higher consumer prices – see again the wage chart above – the government and unions are calling for higher pay. Given that the market for labour is as tight as a drum, with retirement stretching it further all the time, it seems likely they will get their way.
How to play this as investors depends upon the expected magnitude of wage hikes. Certainly, there have been some arresting headlines; last month Fast Retailing announced 40% pay rises for its Uniqlo staff in Japan.8 But elsewhere the indications are for more muted growth, such as the January survey of private businesses which reported that just 2.75% wage increases were planned on average.9 For our part, we think that companies like engineer staffing company TechnoPro and direct online recruitment business Visional are best placed to benefit from the febrile labour market.
We remain sceptical that wage growth will be sufficiently large or sustained to initiate a full-blooded consumption boom. A big part of the reason for this is that Japanese labour productivity is so poor. Why pay more for workers when their output is so disappointingly low? Which takes us to our next issue.
How to play this as investors depends upon the expected magnitude of wage hikes. Certainly, there have been some arresting headlines; last month Fast Retailing announced 40% pay rises for its Uniqlo staff in Japan.8 But elsewhere the indications are for more muted growth, such as the January survey of private businesses which reported that just 2.75% wage increases were planned on average.9 For our part, we think that companies like engineer staffing company TechnoPro and direct online recruitment business Visional are best placed to benefit from the febrile labour market.
We remain sceptical that wage growth will be sufficiently large or sustained to initiate a full-blooded consumption boom. A big part of the reason for this is that Japanese labour productivity is so poor. Why pay more for workers when their output is so disappointingly low? Which takes us to our next issue.
3. Japan is agonisingly inefficient
For anyone who has had the pleasure to ride the Japanese bullet train or shinkansen, the claim that Japan is inefficient must seem preposterous. The near silent arrival and departure of these lightening-fast trains, at second-level precision to the timetable, is surely the epitome of efficiency? But this would be to mistake customer service – in which Japan certainly is a world champion – with efficiency. In reality, the gears of both the corporate and government sectors grind slowly, encumbered by bureaucracy and paper. See below for a comparison of productivity across major economies and blocs.10
Source: OECD, 2022
Japan’s problem lies not with its highly automated manufacturing sector, but in services and in clerical functions of all sectors. Here, business practices are often antiquated, and the application of digitisation is minimal. According to the World Competitiveness Rankings by IMD, a Swiss business school, Japan is placed 29th globally – just behind Qatar, New Zealand and Spain.11 None of this will come as a surprise to those who have visited a Japanese office, often the only place one can reliably still see a functioning fax machine.12
On this score, Japan simply must change. As the country’s stock of workers dwindles, remaining employees need to be allocated more efficiently and be digitally tooled so that they might do more. Japan’s business process outsourcers allow client companies to focus scarce labour on core, productive work. We prefer well managed, profitable niche players like Prestige International and Direct Marketing Mix. Software and IT consultancy companies such as Simplex and WingArc are dragging corporate Japan belatedly into the present day and growing themselves as they do so.
For most sectors, the imperative to boost productivity comes from the supply side – the shrinking labour force – but there are implications for demand too. This is where we head now.
On this score, Japan simply must change. As the country’s stock of workers dwindles, remaining employees need to be allocated more efficiently and be digitally tooled so that they might do more. Japan’s business process outsourcers allow client companies to focus scarce labour on core, productive work. We prefer well managed, profitable niche players like Prestige International and Direct Marketing Mix. Software and IT consultancy companies such as Simplex and WingArc are dragging corporate Japan belatedly into the present day and growing themselves as they do so.
For most sectors, the imperative to boost productivity comes from the supply side – the shrinking labour force – but there are implications for demand too. This is where we head now.
4. Healthcare costs are rising, putting pressure on public finances
Japan is home to more than 90,000 centenarians, almost double the number it had ten years ago. Japanese life expectancy is the highest in the world. It is inevitable then, that demand for healthcare will continue to rise. Indeed, if there is anything surprising about the chart below, showing total healthcare spending over time, it is that its growth is not even sharper.15
Source: OECD, 2022
Japanese healthcare spending is growing, but only steadily
The obvious way for investors to play this is to buy businesses which supply the services demanded – just buy care homes, right? Wrong, or so we think. These businesses require large amounts of capital to grow through the building of new facilities. Their constant interaction with vulnerable residents brings an element of risk often ignored. Care home operators are also frequently less profitable than expected, not least when it is the cash-strapped government picking up the tab.
We are convinced that a better approach is to take a look down the other end of the telescope – focusing not on businesses which should benefit from growing demand per se, but at those easing the pressure on a government struggling to pay for this inexorable burden. Here, we like JMDC which uses its stock of medical data, gleaned from its work with the insurance industry, to boost productivity across the medical sector. This mention of government brings us to the final point.
We are convinced that a better approach is to take a look down the other end of the telescope – focusing not on businesses which should benefit from growing demand per se, but at those easing the pressure on a government struggling to pay for this inexorable burden. Here, we like JMDC which uses its stock of medical data, gleaned from its work with the insurance industry, to boost productivity across the medical sector. This mention of government brings us to the final point.
5. Japan is run for and by older people, which has implications for politics
Making a link between age and political persuasion is a dangerous thing to do, as any Bernie Bro or Corbynista will tell you. But it does not seem a great leap to suggest that an aging electorate might generally favour conservative over progressive policies. For those of advancing age, a Japan which continues to look like the comfortably prosperous country they have long known might be preferable to one given to radical change. This is one plausible explanation for the ruling LDP’s lock on power, which has been broken only twice – and even then, briefly – since the end of the Second World War.
Source: Nikkei
In Japan, the centre-right LDP has no real electoral competition
The ruling LDP’s support rate appears to be unassailably high, even though public perception of the current Prime Minister, Fumio Kishida, is only luke-warm.16, 17 Far be it from us to stray from our lane into political prediction, but if the LDP is the party of the elderly and the electorate itself is of ever advancing age, it seems unlikely that a political shock is on the horizon.
An interesting observation perhaps, but what does this mean for investors? To say that it implies political stability in an increasingly unstable world is to damn Japan with faint praise. More meaningful is that it implies that the current realities of Japan – as set out above – are more likely to be persistent. It pours cold water on any great hope that mass immigration will be used to offset Japan’s demographic trajectory. There is little clamour amongst Japanese to ship in more foreigners to work, and that seems unlikely to change.18
An interesting observation perhaps, but what does this mean for investors? To say that it implies political stability in an increasingly unstable world is to damn Japan with faint praise. More meaningful is that it implies that the current realities of Japan – as set out above – are more likely to be persistent. It pours cold water on any great hope that mass immigration will be used to offset Japan’s demographic trajectory. There is little clamour amongst Japanese to ship in more foreigners to work, and that seems unlikely to change.18
Source: Pew Research Centre
Most Japanese are content with the current level of immigration
The article from the BBC’s outgoing Tokyo correspondent is an interesting read, and we recommend it. It is also a somewhat a dispiriting one. We hope that our response is more hopeful. We accept that Japan faces challenges, and that these may not be fully surmounted. As an aside, we think that many of these challenges will also emerge, if they have not already, in other countries which are getting older on average. But our key message is that for investors who have become well adapted to the prevailing realities of Japan, opportunities about. It is our belief that our combination of common sense and contrarianism is well tuned to find them.
1 Japan was the future but it’s stuck in the past – BBC News
2 There Are No Children Here. Just Lots of Life-Size Dolls. – The New York Times (nytimes.com)
3 Japan’s empty villages are a warning for China | Financial Times (ft.com)
4 Bloomberg, Feb 2023
5 Smith, Benthos, December 2022
6 Minimum wage rises to exceed central government proposals in 22 prefectures | The Japan Times
7 Smith, Benthos, CLSA, Jan 2023
8 Uniqlo owner to raise wages in Japan by 40% as inflation climbs | Financial Times (ft.com)
9 Smith, Benthos, CLSA, Jan 2023
10 OECD, Jan 2023, Level of GDP per capita and productivity (oecd.org)
11 World Digital Competitiveness Rankings – IMD
12 Japan’s reliance on fax machines lambasted by coronavirus doctor | The Independent | The Independent
13 Centenarians in Japan top 90,000 for first time | The Japan Times
14 List of countries by life expectancy – Wikipedia
15 MHLW, Nippon.com, Japan’s Healthcare Expenditures Reach Record High | Nippon.com
16 Smith, Benthos, Jan 2023
17 Japan PM’s approval rating sinks to record-low 35% – Nikkei Asia
18 Pew Research, 2018, Most Japanese content with current immigration numbers | Pew Research Center
2 There Are No Children Here. Just Lots of Life-Size Dolls. – The New York Times (nytimes.com)
3 Japan’s empty villages are a warning for China | Financial Times (ft.com)
4 Bloomberg, Feb 2023
5 Smith, Benthos, December 2022
6 Minimum wage rises to exceed central government proposals in 22 prefectures | The Japan Times
7 Smith, Benthos, CLSA, Jan 2023
8 Uniqlo owner to raise wages in Japan by 40% as inflation climbs | Financial Times (ft.com)
9 Smith, Benthos, CLSA, Jan 2023
10 OECD, Jan 2023, Level of GDP per capita and productivity (oecd.org)
11 World Digital Competitiveness Rankings – IMD
12 Japan’s reliance on fax machines lambasted by coronavirus doctor | The Independent | The Independent
13 Centenarians in Japan top 90,000 for first time | The Japan Times
14 List of countries by life expectancy – Wikipedia
15 MHLW, Nippon.com, Japan’s Healthcare Expenditures Reach Record High | Nippon.com
16 Smith, Benthos, Jan 2023
17 Japan PM’s approval rating sinks to record-low 35% – Nikkei Asia
18 Pew Research, 2018, Most Japanese content with current immigration numbers | Pew Research Center
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