Japan shows how to defeat secular stagnation

As if out of nowhere, everyone's archetype of secular stagnation is leading the Group of Seven developed economies in life expectancy, per capita growth and, for the first time in decades, an end to the deflation that oppressed chief executive officers and global investors alike. And if that is not enough, this economic juggernaut — better known as Japan — is also providing the biggest dollar denominated stock market returns anywhere in the world.

The Land of the Rising Sun experienced its largest decline in population last year — of more than 500,000 to 125.4 million people — and residents are living longer than 84 years on average (fourth among 240 countries). And yet, the world's third-largest economy had the most significant per capita increase in gross domestic product between 2013 and 2022 in local currency terms. That 62% appreciation to ¥4.72 million ($32,000) as the size of its society shrank 2% easily surpassed the U.S. (16% with a 6% rise in population), Canada (45% and 12%), the U.K. (48% and 5%), Germany (32% and 5%), France (33% and 3%) and Italy (30% and -1%), according to data compiled by Bloomberg.

The Japanese penchant for living longer and prospering to an extent widely unanticipated at the end of the last century is turning out to be a lesson in managing wealth creation for the rest of the demographically challenged G7 and a bonanza for some of the savviest investors. Actively managed exchange-traded funds just poured $1.5 billion into Japan, the most since data for the $13 trillion ETF industry was compiled in 2018. The surest sign that money managers worldwide favor Japanese companies, instead of allocating their bets to passive indexes, coincides with the most bullish outlook among G7 markets, with analysts raising their price targets by 10% during the past three months.

Japan equity, as measured by the Bloomberg World Large & Mid Cap Index, has gained 95% since 2020, a total return (income plus appreciation) superior to the U.S. (64%), Canada (76%), the U.K. (73%), Germany (47%), France (78%) and Italy (84%). Toyota, the world's leading automotive company for vehicle sales, fetched a record ¥2,911 per share earlier this month, after appreciating 57% to a $307 billion valuation over the past nine months.

"Over the last three years, it's been quite a good period to be a relatively contrarian stock picker,” said Colin McQueen, manager of T. Rowe Price International Value Equity Fund, based in the U.S. city of Baltimore. The fund produced a 23% return the past 12 months when measured in dollars, beating all of its global peers investing in Japan. Among the 74 mutual funds or ETFs with at least $5 billion and 10% or more invested in Japanese stocks for at least five years, the 56-year-old London-based McQueen, who started managing the fund in 2019, outperformed his rivals by climbing from No. 16 to No. 1. He doubled the returns generated by the S&P 500 and world equity indexes, and crushed the Nikkei 225 by 10%, according to data compiled by Bloomberg.

"Japan has probably been a bit more of a stealth opportunity,” McQueen said earlier this month. "It's been one market where value-driven stock strategies added a lot over the last year (after) a number of stocks that were returned to their COVID lows seemed to be overdone in market pessimism.” The companies contributing most to McQueen's total return include MatsukiyoCocokara, Mitsubishi UFJ Financial Group, Sumitomo, Asics, Hitachi, Nippon Steel, Kao, Nippon Sanso Holdings, Olympus, Taiheiyo Cement and Tokyo Electron.

The prevailing narrative of Japan in terminal dysfunction because of its declining population, seemingly hidebound businesses, and perceived resistance to immigrants and greater labor participation is increasingly debunked by some of the most influential commentators, such as Nobel laureate Paul Krugman and Adam Tooze, Shelby Cullom Davis Chair of History at Columbia University in New York.

"Adjusted for demography, Japan has achieved significant growth,” Krugman wrote in a New York Times column in July. "Japan, rather than being a cautionary tale is kind of a role model — an example of how to manage difficult demography while remaining prosperous and socially stable.” During the administration of the late Prime Minister Shinzo Abe, who was assassinated on July 8, 2022, "Japanese women did enter the labor market as never before,” Tooze wrote in his July 2022 Chartbook blog on Substack. "The fact that a significantly larger percentage of Japanese women are in paid employment than in the United States is a remarkable historical turnaround.”

Much of the inspiration for Abenomics came from Kathy Matsui, now a founding general partner of Tokyo-based MPower Partners, who in the 1990s — when she was the sole woman among hundreds of Japanese investment strategists — routinely topped Institutional Investor's All-Japan team because of her focus on women in the economy. Matsui became the first female partner at Goldman Sachs Japan and argued in her 1999 thesis "Womenomics” that increasing female participation in the workforce would substantially boost Japan's gross domestic product.

Economist Noah Smith, who considers Tokyo "the new Paris” because of its cultural dynamism, wrote in a 2019 Bloomberg Opinion column that Tokyo's diversity "is in large part the result of Japan's increasingly open stance toward immigration” and, more recently: "Japan is not an island of racial purity. Instead, it is a fairly normal rich country, dealing with fairly normal issues of immigration, diversity, minority rights, racism, and nationhood.”

That means that "the prospects for Japan look reasonably good as an economy” and "attractive” as an investment, said McQueen. Amid the decline in the working age population, "the big increase in labor force participation, particularly amongst women” coincides with "a trend toward corporate reform to the benefit of shareholders.”

The transformation shows no signs of slowing. "The landscape has changed from deflation to inflation,” said Takeshi Niinami, CEO of closely held Suntory Holdings and chairman of Japan's Association of Corporate Executives, one of the country's largest business lobbying groups. "Inflation means the private sector has to take a key role to invest because money is less valuable,” he said during an interview earlier this month.