NEW YORK – How much longer can the sun shine on Japan's stock market?
Continue Reading Below
The Tokyo Stock Exchange has been among the world's hottest for years and the Nikkei 225 index recently topped the 20,000 level for the first time since 2000. Usually when an investment is doing that well, euphoria ensues. But Japanese stocks have a long history of disappointing investors. The reputation is so strong that veteran managers say they're still encountering skepticism.
Deep changes underway in the economy and corporate culture, though, are pushing managers to say Japanese stocks can shake that reputation.
"I know it hasn't been in the past, but I think it is getting to the point where there is a long-term investment story here in Japan," says Kenichi Amaki, co-manager of the Matthews Japan fund.
To see where the skepticism comes from, just look at the market's track record. Since the Nikkei index's bubble burst in 1989, it has had more down years than up. An investment in the broader TOPIX index of Japanese stocks has generated a total return of 57 percent over the last 20 years, including dividends. The Standard & Poor's 500 index of U.S. stocks, meanwhile, has posted a return of nearly 500 percent.
The easy money has also already been made in Japanese stocks, and the Japanese government is in the midst of reforming its regulations -- the most difficult part of its "three-arrow" strategy to improve the economy. And Japan's longstanding issues of an aging population and high debt haven't gone away.
Continue Reading Below
But many managers nevertheless argue for sticking with the world's third-largest economy. Among their reasons for optimism:
— A CHANGING CULTURE
Japanese companies are becoming better listeners.
Fund managers have complained for years that Japanese companies paid little attention to shareholders and cared more about dominating their market than boosting returns. But a shift is occurring, and last year the Japanese government published a "stewardship code" to improve corporate communications in the hope of improving returns.
Companies are giving more consideration to shareholders and are using some of their cash hoards to pay dividends and repurchase their own stock. Fanuc, a Japanese robot maker, said earlier this week that it will start paying out 60 percent of its net profit as dividends, double what it paid before.
Or consider a concept called return on equity. It's a popular measure on Wall Street that shows how efficiently a company is earning profits, and it's one that famed value investor Warren Buffett often considers.
Japanese companies are now discussing their returns on equity when, 15 years ago, many had never head of the term, says Matthews' Amaki.
Many U.S. investors would likely see Japanese companies as still far behind on corporate governance issues. "But for guys like us who have been looking at Japan for a long time, we're looking at the glass as half full," Amaki says. "Not only that, but at last there's a little bit of water in it."
— IT'S NOT JUST THE YEN
The value of the yen began tumbling in late 2012, jolting Japanese stocks higher.
A weaker currency helps Japanese exporters because it means each $100 in sales are worth more in yen. That's why Japanese stocks rose for years, as the yen fell.
But this year, Japanese stocks have been able to buck the trend. The TOPIX is up 13.2 percent even though the yen is close to flat against the dollar.
What's changed? Japanese companies are now feeling the full benefits of yen's decline over the last few years, says Masakazu Takeda, portfolio manager at the Hennessy Japan fund. They're able to reap additional profits with the exchange rate at nearly 120 yen to the dollar, when they had calibrated their operations to survive at a level of 70 yen to 80 yen.
That means corporate profits can stay strong for years, even if the yen doesn't fall any further, Takeda says. He owns roughly two dozen companies in his fund, and virtually all of them are reporting record profits.
"I'm a lot more optimistic than four or five years ago," he says. "I had nothing to tell investors then because Japan was going nowhere." Now he expects the Japanese market to rise about as much as corporate earnings do, about 7 percent to 10 percent annually over the long term.