YOUR GOALS,OUR COMMITMENT.

Nikkei reaches all-time high: five reasons therally will endure
Japan equity was the best-performing asset class in 2023, but despite the Nikkei reaching all-time highs in
2024, after a 34-year wait to beat the previous high-water mark, Japan also recently experienced economic
contraction. Against that backdrop, Japan Equity Investment Director Junichi Takayama offers five reasons
why Japan’s economic resurgence still has ample runway.

By Junichi Takayama, Japan Equity Investment Director
14 March 2024

One: Domestic spending to be unleashed by pent-up demand and highest wage
hike in decades
It was somewhat surprising in February that Japan was initially reported as having dipped into a technical recession
in late 2023, following two consecutive quarters of negative gross domestic product (GDP) growth (according to data
released on 11 March, Japan’s annualised Q4 2023 GDP was revised to show a growth of 0.4%; the preliminary figure
showed a contraction of 0.4%). It is worth remembering, however, that those GDP figures are in the rear-view mirror,
whereas stock market investors look further out and expect to see an economic recovery in 2024.
One such example can be seen in the expected recovery in Japanese consumption. The combination of extended
pent-up demand and the highest wage hikes in decades, following the 2023 “Shunto” spring wage negotiations, islikely to lead to higher consumer spending in Japan in 2024 and beyond. Those Shunto negotiations in 2023 marked
a crucial milestone for the Japanese economy as confidence returns. These annual wage negotiations between labour
unions and employers resulted in the highest wage increases in decades, a response not only to the rising cost ofliving but also as a strategic measure to boost economic growth through enhanced consumer spending, and wage
growth appears to be gaining momentum in 2024.
The “forced savings” of Japanese consumers, estimated at Japanese yen (JPY) 50 trillion, could serve as a catalyst forsustained economic growth as these savings are deployed across a number of different sectors. And never before has
Japan looked so exciting for cash-rich domestic consumers.

FOR SOPHISTICATED INVESTORS ONLYNIKKEI REACHES ALL-TIME HIGH: FIVE REASONS THE RALLY WILL ENDURE

Chart 1: Household cash and deposit
1120
1100
1080

Excess savings(JPY trillion)

1060
1040
1020
1000
980
960
940

Source: Bank of Japan as at end-September 2023

Chart 2: Percentage wage increases in spring wage offensives
7.00
6.00

(%)

5.00
4.00

3.6

3.00
2.00
1.00
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023

0.00

Source: Minister of Health, Labour and Welfare of Japan as at August 2023

Two: Recovery in inbound tourism set to gain further momentum
Domestic consumption is not the only important factor for Japan’s economic strength. The tourism sector is also on
the brink of a significant resurgence. Pre-pandemic, Japan's tourism sector was a significant economic contributor,
with spending by inbound tourists reaching JPY 4.8 trillion in 2019, accounting for approximately 0.9% of Japan'sGDP. However, pandemic-related travel restrictions led to a sharp decline in inbound tourism, damaging relatedindustries and the broader Japanese economy.
But the turning point for Japan's tourism sector came in April 2023 when the government lifted all COVID-19-related
border control measures. The easing of restrictions has led to a rapid increase in inbound tourists, revitalising Japan’s
tourism industry and associated businesses, including hospitality, retail and transportation.
Nowhere is the recovery of Japan’s tourism industry more relevant than for China. Chinese tourists' affinity forJapanese goods—from electronics and cosmetics to fashion and culinary delights—has helped make tourism such asignificant component of Japan's GDP. Back in 2019, China stood as the largest contributor to inbound tourism
spending in Japan, accounting for a staggering 37% of all such expenditures.

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2NIKKEI REACHES ALL-TIME HIGH: FIVE REASONS THE RALLY WILL ENDURE

Up until now, however, China’s economic recovery has been more muted than expected. But as China rebounds in
2024, its burgeoning middle class, armed with savings and a pent-up desire for travel and consumption, will likely
look towards Japan as its primary destination. This revival is not merely about restoring pre-pandemic levels of
tourism but expanding them, driven by both the volume of tourists and the intensity of their spending in the years
to come.
The weakness of the Japanese yen is another key factor in driving the recovery of inbound tourism. A weaker yen
makes Japan a more attractive destination for international tourists, reducing the cost of travel, accommodation, andshopping in Japan. This advantage is likely to increase not only the number of tourists visiting Japan but also theamount they spend per visit.
Chart 3: Number of inbound tourists
31.9

35

31.2
28.7

30

(million)

25.1

24.0

25
19.7

20
13.4

15
10
4.8 4.85

6.7
5.2 5.2 6.1

7.3 8.3 8.4 6.8

8.6

6.2

8.4

10.4
4.1

3.8
0.2

0

Source: Japan National Tourism Organization (JNTO) as at December-end 2023

Chart 4: Monthly inbound tourism spending
600
500(JPY billion)

400
300
200
100

2000/01
2000/10
2001/07
2002/04
2003/01
2003/10
2004/07
2005/04
2006/01
2006/10
2007/07
2008/04
2009/01
2009/102010/07
2011/04
2012/01
2012/102013/07
2014/04
2015/01
2015/10
2016/072017/04
2018/012018/10
2019/07
2020/04
2021/01
2021/102022/072023/040

Source: Bank of Japan as at December-end 2023

Three: TSE shows its teeth in improving corporate governance
The Tokyo Stock Exchange (TSE) has initiated a series of initiatives aimed at fostering transparency, accountability andshareholder value. The most significant of these was its 2023 Guidance aimed at driving companies to adopt
improved corporate governance practices. The goal is to ensure Japanese companies listed on the premier stock
markets comply with a governance framework that promotes sustainable growth and protects investor interests.
Moreover, since January 2024, the TSE has adopted a “naming and shaming” strategy of publicly disclosing lists ofcompanies that are either in compliance with or in defiance of these governance initiatives. Those failing to comply

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3

NIKKEI REACHES ALL-TIME HIGH: FIVE REASONS THE RALLY WILL ENDURE

with the guidelines are left off the compliance list, creating a highly conspicuous and direct incentive for companies
to elevate their governance practices or face reputational risks.
The TSE's more proactive stance on corporate governance could have far-reaching advantages for the Japaneseequity market, providing a clearer framework for assessing company performance beyond traditional financial
metrics. These initiatives, which should see compliant companies attracting greater foreign investment, present
Japan as a maturing investment market that is increasingly attractive from a governance perspective.

Four: Japanese companies are finally ready for shareholder engagement
Shaking off its characterisation as inherently conservative in its approach to corporate governance, Japan is now
actively embracing shareholder activism, a shift confirmed by a significant increase in activist campaigns andshareholder proposals demanding transparency, accountability and enhanced corporate performance. Since 2019,the number of activists and shareholder proposals in Japan has more than doubled and quadrupled, respectively,
with shareholders becoming more vocal and assertive in their demands. This increase in activism is not just about
challenging management but about fostering a culture of constructive engagement, aiming to unlock value and drive
long-term growth.
Another key indicator of Japan's readiness for shareholder engagement is the more strategic approach to dividends.
Current dividend yields of Japanese companies are significantly higher than long-term interest rates, signalling
confidence in earnings and an improvement in governance practices. High dividend stocks not only offer attractive
income but also low interest rate sensitivity and downside protection, appealing to a wide range of investors seeking
both growth and stability in the form of capital and income gains.
The rise in shareholder proposals, the changing dynamics at AGMs, the acceptance of once-taboo hostile takeovers,
the increase in management buyouts, and the strategic use of dividends all point to a significant shift in Japan's
corporate governance culture.
Chart 5: MSCI Japan vs MSCI Japan High Dividend Index
1.6
1.5
1.4
1.3
1.2
1.1
1
0.9

MSCI JapanMSCI Japan High Dividend Yield

Source: Bloomberg as at 26 February 2024

Five: Japanese value stocks still trade at a significant discount to book value

Japanese value stocks have historically offered investors an opportunity to buy into companies at prices less thantheir intrinsic value. Despite the overall strong performance for Japanese equities in 2023, value stocks—particularly
small and mid-cap companies—did not fully participate in the rally. This underperformance has been attributed toseveral factors including investor preference for large caps and growth stocks amid the technology stocks rally,heightened macroeconomic uncertainties, and a domestic market still overlooked by international investors.
As a result, many of Japan’s small and mid-cap value stocks are still trading significantly below book value, andtherefore still have room to move much higher. As the market begins to shift its focus down the market cap spectrum,
due to changing economic conditions or a re-evaluation of risk, these stocks stand to benefit significantly.
These five trends should present investors with plenty of good reasons to consider increasing their Japanese equity
allocations. For international investors, Japan’s corporate reform progress and expected economic recovery offers aclear and immediate opportunity to tap into a market showing clear signs of a strong rebound. Increasing allocation
to Japanese equities now could provide not just diversification benefits but also the potential for meaningful returns

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4NIKKEI REACHES ALL-TIME HIGH: FIVE REASONS THE RALLY WILL ENDURE

as Japan's economic recovery continues to unfold. And when considering investing in Japan, it is worth noting thatinvestors are more likely to benefit from an active approach than in other regions.

Active management does better in Japan
More so than in any other region, active management in Japan consistently outperforms benchmarks over longer
time periods. This is particularly true in the small and mid-cap segments of the Japanese market, where inefficiencies
such as less analyst coverage and a general lack of investor attention are more pronounced. Many small and mid-cap
companies in Japan are niche market leaders with solid business models and robust growth potential. Active
managers are adept at identifying these companies, assessing their true value, and understanding their growth
drivers.
For investors considering an allocation to Japanese equities, an active management approach presents a compelling
proposition, ensuring investors benefit from a deeper and richer understanding of the dynamism and potential ofJapan's equity markets.
Chart 6: Percentage of Japan funds outperforming their benchmarks (10 years)
60.0

53.0

50.0

(%)

40.0
26.4

30.0
20.0

15.5
9.4

10.0

2.7

3.9

Global Equity

International
Equity0.0
Japan LargeJapanCap
Mid/Small-Cap

All Japan
EquityUS Equity

0.0
Emerging
EquitySource: Nikko AM based on S&P Dow Jones SPIVA Japan Scorecard Mid-Year 2023

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