Japan’s new direction

0:06Pushkin. Japan is the world's third biggest economy, and this year its stock market, which usually is pretty unremarkable, has showed some really impressive signs of life. It's up 20 % 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. Hey, Ethan. How are you? I'm well, thanks. I love talking about Japan.

0:46I feel like it's like a bug that bit me. And I want to talk about it as much as our producers will let us talk about it. And I feel like you're the same way. You write about this a lot, too. 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. I know there's a private banker who I talk 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.

1:22It 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. 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, toward the beginning of this year? The buy case, well, it was a few things.

1:57It is partly the weak yen, 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?

2:44So 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 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. Absolutely. It comes down to what model of capitalism is going to exist in Japan long term.

3:24Getting a bit deeper meaningful here, aren't you, Ethan? I mean, come on. There's a great piece by the journalist and academic Stephen Vogel called Japan's Ambivalent Pursuit of Shareholder Capitalism. That kind of goes through how international finance tried to export a US and maybe UK style shareholder first capitalist model to Japan. And the Japanese were kind of like, eh? We believe in stakeholder capitalism here in Japan. But that does seem to be changing, Katie, as you mentioned. There was an initial push in the early 2010s during kind of the Abenomics era, 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.

4:07that if you make excess profit, you're not just going to put it in the bank and sit on it. You're not going to just buy your rivals slash friends' shares and do nothing with it. You're going to take that cash and return it to the investors that have given you their capital to do business with. Yeah. And there's a lot of other kind of really big factors at play here, right? 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 aging population. One of the knock-on effects of that, investors constantly say to me, is that suddenly workers are much more valued.

4:44And so if you are, you know, on the younger side, and you are a worker, and your company decides to rationalize 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 rationalization 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.

5:25So that was the case for Japan kind of coming into this year. And maybe I'd add to that list the fact that people were looking for a China alternative within Asia. 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 question of why. And you framed this in a nice recent column, Katie, that 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.

6:04Now, 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 NISA program.

6:42It's kind of modeled on the British ISA scheme for what's kind of, you know, tax free or tax efficient investment programs. And that's going to 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. 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. 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.

7:24And I think most notably last week, there was this great interview we had in the EFT with the head of JPX, which owns 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 FTSE 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. Yeah. Look, they're not framing it exactly like that, to be absolutely fair.

8:00They should, actually. So really interesting interview with Hiromi Yemaji, who, as you say, is chief executive of JPX, which owns the Osaka and Tokyo exchanges. Now, back in March, he said, 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.

8:42so 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 word 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.

9:27And so what investors are telling us is it's going to be a really big incentive to companies to really supercharge efforts if they're not making them already because a lot are not making them because, like I say, it's not obligatory. 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 you to kind of infer who would be on the hypothetical naughty list. Yes, that's one way of looking at it. I think that there's a reason that they're increasing this pressure, right? Which is that when the Tokyo Stock Exchange published these aspirational recommendations earlier this year, only about a third of companies, actually 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.

10:15And 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. Yeah, it is a gentle but meaningful escalation. And as the JPX chief executive was telling us, This kind of nudge is important in Japanese culture and in Japanese markets. 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 earn the respect of your peers. And to be even implicitly on a list of disreputable or poor behavior can imply a lot of qualitative pressure.

10:54So to 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, MISA 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. 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.

11:33And Japan is, I'm about to say, it's not an island, but it is literally islands. But what I mean is, you know, 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. And just to wrap up, Katie, I think this is really about capitalism. Again, the explicit economic plan of the Kishida administration is to realize a new form of capitalism, to double asset-based income. That's their plan for the economy, to revitalize an economy that's been a laggard for 20 or 30 years.

12:13Remains to be seen if it'll work, of course. But I think if you wanted to make the case for global investors, I think you do kind of 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 hopefully everyday Japanese people too. This is profound stuff, Ethan. Where's Robert Armstrong when you need him? All right, Katie, we'll be back in a moment with Long short.

12:46Welcome 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. Oh, my God. I love this so much. 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 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 this.

13:32Why 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 really just incredible. But I love how petty everyone is in this story, but I also hate it. Can we just be adults here, right? Like, why did this have to escalate to management? Why did he have to get fired for this? It's just ridiculous. So you want to purchase more sandwiches is what you're saying on the company's dime. 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?

14:08Like, come on, this is an expense the company's already allotted money for. What if I'm just really hungry? 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. 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.wuwu at ft.com. You will feel better having told me your confession. All right, Katie, are you long something? I am very much long VC bros, really hurting in the higher interest rate environment and taking it out on blog platforms.

14:50So I hope you have seen, if you haven't, do check it out, Mark Andreessen from A16Z, 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. And the section is called The Enemy. So Mark Andreessen wants you to know we have enemies and they include risk management,

15:30ESG 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. Mark Andreessen, are you expensing illegal sandwiches? Let me know. All right, 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.

16:06Catch that. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Jacob Weisberg, and Jess Trulia. 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 slash unhedged offer. I'm Ethan Wu. Thanks for listening.

16:46We'll be right back.