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Three exogenous shocks of pandemic, global inflation, and geopolitical tension made a big wakeup call on Japan. Followed by three endogenous shocks: BOJ’s behind-the-curve policy, domestic cost push inflation, and corporate governance reform.
Supply chain disruption from covid and high energy price from global inflation gave companies an excuse to pass through costs for the first time. Geopolitical tension led the nation to revamp semi-conductor investment with government subsidy as we see in TSMC building a factory in Kumamoto.
BOJ maintained a dovish stance while the Fed is trying to cool off inflation as Japan had a delayed recovery from COVID, unlike the U.S.’s V-shaped recovery. In contrast to the Fed’s attempt to be on ahead of curve, BOJ intentionally stayed behind the curve, making sure to wait till they see real wage growth spring in 2024. Such policy gap pushed the yen down from 130 yen to 151 yen in 2023, and on top of global energy price hike, people had to accept price hikes with increase in importing goods.
On the other hand, Japan became a great place for tourists to visit, that boosted the service sector inflation level. Tokyo Stock Exchange’s corporate governance reform finally started to work as they set criterion in terms of liquidity and disclosure to stay in the Prime Market. They even sent a warning letter to companies below PBR 1x, which makes up over 50% of companies in index. This is how we were exiting from 30 years of deflation.
Last year, the market rallied with expectation, and this year, the market will conduct fact checks on two structural shifts: inflation and governance reform. We are positive on such change to take place.
First, the wage hike from the spring labour negotiations - Shunto - was 5.2%, at its highest level in 33 years. If this year's core CPI stabilizes above 2%, the spring labour negotiation, which reflects the prior year's inflation rate, will be high again in 2025.
As we talk to companies, wage hikes are a must due to severe labour shortages. While declining population was talked about, labour population was steady around 67 million pre-COVID, underpinned by the rise of women and elderly participation ratio but that effect is finally maxing out. Real wage growth is expected, and consumption recovery to follow.
Our on the ground research shows luxury spending has been robust driven by dual income households and a young generation working at large companies who benefited from this wage hike initially, and we expect to see this effect will come through among other demographics.
Second, inflation would make companies less tolerable to hold onto cash, surplus capital and low margin businesses. It has been Japan-specific culture to build relationships based on cross shareholdings, but along with the TSE warning, Financial Agency Services demanded insurers to sell cross shareholdings this February. We have seen companies finally started to unwind cross shareholdings and use it for buyback or dividend payout to improve shareholder return. Companies raised wages, but the margin could be still historical high as cost pass through became a norm. Wage rises, company margins and ROE improves, the equity market booms, and consumer sentiment improves. We are seeing the beginning of this virtuous cycle.