Homogenised bulls

Using peer pressure to create a stockmarket rally

Currency-adjusted, Japan is the best-performing major stock market so far this year. This has continued the uptrend that began in late October of last year, a move that started with the announcement of an increase in QE from the Bank of Japan. This is the second phase of the Japanese equity bull market that was kick-started by Abe’s election victory and the introduction of Abenomics in late 2012.

That first phase saw shares rally as the currency fell sharply, government spending was boosted and an aggressive QE policy from the central bank. For the most part it was driven by foreign investors who were quick to understand the reflationary impact of these policies and their impact on corporate earnings. Japanese domestic investors were not major buyers during this phase of the market. Then from May 2013 to November 2014, the market consolidated the very substantial gains made in the prior six months.

Over those eighteen months, a number of key, interlinked, institutional changes were, however, implemented in Japan as part of Abe’s “third arrow” of structural reforms. Two of these have been crucial for the stock market and both rely heavily on the Asian concept of “face” and the strong Japanese desire not to be seen as out of line with the rest of society.

The first change has been to assert control of the Government Pension Insurance Fund (the GPIF). By insisting that it take notice of the Bank of Japan’s new inflation target of 2% and the effects of the QE programme aimed at generating that inflation and by replacing the previous chairman, the government has forced the GPIF to reconsider its strategic asset allocation, which was heavily biased to Japanese Government Bonds with negligible yields, towards much higher weightings of Japanese shares and international securities. As the leading pension fund in the country, the actions of the GPIF are carefully monitored by the other pension and investment funds in Japan and then copied, as is typical in the Japanese culture.

The second change has been the introduction of a new stockmarket index, the JPX Nikkei 400, which the GPIF is using as its benchmark for the domestic Japanese equity mandates that it is awarding as part of its move towards greater equity exposure. Membership of this index is not solely determined by market capitalisation, but also by companies’ success in implementing good standards of corporate governance together with operating profitability and, most crucially, corporate return on equity – which for shareholders is possibly the critical measure of profitability. For companies that would normally expect to be included in any list of the top 400 Japanese companies, the discovery that they do not qualify for this index has become a mark of shame.

After decades of keeping shareholder interests a long way down the pecking order of corporate priorities, the introduction of this index, and its use by the leading investor in the country, has finally produced a change in corporate mindset. For example, Amada, a leading Japanese toolmaker, was mortified to find itself excluded from the index last summer. It has recently announced that for the next two years it will pay out half of its net profits as dividends, use the other half to buy back shares and hire two independent non-executive directors by the middle of next year.

The result of these changes is a dramatic re-allocation towards equities by Japanese institutional investors – this is most likely to be seen in the new financial year which has just begun (April 1). For the first time in a generation Japanese investors are likely to become significant net buyers of Japanese shares. Simultaneously, Japanese companies finally have a good reason to be far more shareholder friendly, to make profits, to declare them as such and to reward their shareholders with dividends from those profits. This is the path trodden by many US companies over the last five years and has been very rewarding for shareholders there. It may finally be time for shareholders in Japan to enjoy the same experience.