With the Tokyo Olympics scheduled to take place later this month, all eyes will be on Japan this summer. While there has been a backlash from the Japanese public as a result of Covid-19 concerns, the intentions of the International Olympic Committee remain in support of the games going ahead. Given this uncertainty has already been priced into Japan’s market, whether the games are staged or not has little impact on our portfolio.
Alongside the Olympic narrative, the re-opening trade has continued to make headlines in the media. This has been a hot topic for markets globally, although economies are opening up at different speeds regionally. Given lagged vaccination, Japan has underperformed global peers year-to-date, while we can expect this gap to narrow as the domestic vaccine rollout gathers momentum. Sentiment will be further supported by the uptick in earnings revisions, commodity reflation and a latent capex boom.
Over the long term, we still believe Japanese equities are uniquely positioned to capitalize on both cyclical tailwinds (accelerating vaccination rollout and sensitivity to the global growth recovery) and structural tailwinds (beneficiaries of evolving technology and corporate governance reform as a game changer) at attractive valuations.
Pick-Up In Vaccination Rollout
From a Covid perspective, Japan has one of the lowest mortality rates globally versus other countries. Figure 1 shows death rates are significantly lower versus other global regions—highlighting Japan’s effective handling of Covid. In fact, the total number of deaths in Japan in 2020 was less than that in 2019, which is a testament to its effective containment measures.
Partly because of this success, Japan’s vaccination rate has been lower than other major countries, however the vaccination rate started to pick up considerably in May (Figure 2).
We’ve witnessed a positive correlation between the pace of vaccinations and equity market returns globally, and with Japan’s vaccination rate recently exceeding the 10% mark, we believe this will help the index catch up with that of the US and Europe. If the vaccinations progress in line with the government targets of one million doses per day, Japan should be able to achieve herd immunity later this year—which may be priced into the equity market sooner rather than later.
Pent-Up Savings A Tailwind For The Domestic Economy
As a cooped-up global population is allowed back outside, we believe the positive trends in economic activity will continue. This will be supported by pent-up savings accumulated during the extended lockdown, as well as extraordinary government stimulus around the world. Japan’s households have put spending on hold during the pandemic—with cash savings having grown by $390 billion since Q4, 2019 – which has resulted in a further increase of household financial assets to $17 trillion1. Alongside these pent-up savings, employee compensation levels have returned to their pre-Covid levels, which will boost consumption. Given this favorable backdrop, we can expect the domestic economy to really hit its stride with accumulated savings deployed as the economy continues to re-open.
Japan As A Key Beneficiary Of Global Recovery
Given Japan’s sensitivity to the global cycle is higher than most countries, the economy should be a key beneficiary of synchronized global recovery in 2021 with the expectation that domestic corporate earnings growth will rebound. Over 50% of the MSCI Japan Index falls under three sectors: industrials; information technology; and automotive-heavy consumer discretionary. This implies that the composition of Japan’s index helps investors enjoy superior returns when global growth starts to improve. If we view this from a style perspective, the weight of value stocks in Japan is almost double that of the global standard, with Japan the best performing market during global value rallies since 2010. We can therefore expect the current environment to provide investors with an attractive risk-reward trade off.