Konnichiwa, Japan

East is east, and, actually, looking better all the time. Well, Japan is, at least. The country’s economy’s on the up and there are some good things happening inside its corporate boardrooms too. It’s been encouraging enough for Warren Buffett to increase his stakes there – and he knows a thing or two.

🕰 Recap

• While much of the world’s fretted about rampant inflation, rising prices awoke a sleeping giant in the east – Japan.
• Faced with the prospect of having to pay more for goods and services down the line, Japanese companies and consumers started spending again, and that’s sparked a resurgent economy: first quarter economic growth was revised sharply higher this week.
• And the winds of change are blowing stronger in the corporate world too, pulling in big-hitting foreign investors.

✍️ Connecting The Dots

US and European macroeconomic clouds are gathering, but the corporate outlook is like a big bright sun, shining through the gloom. Investors have been grappling with this conundrum for more than a year now and they’re still no closer to any clarity. But there’s one place where no such conflict exists, where investors can have their macroeconomic cake and eat their corporate profit outlook too – Japan. Indeed, everything seems to be falling into place for the country once derisively dubbed “land of the setting sun”. And it’s all down to inflation.

See, after Japan’s mighty 1980s asset bubble burst, it sparked a 30-year death spiral of deflation – that’s falling prices – and no amount of ultra-low interest rates or central bank bond-buying could drag Japan out of it. But, with prices now rising, Japanese consumers and companies have opened their dusty wallets, and spending has picked up. And that’s led to the country’s economy posting an enviable 2.7% growth rate for the first quarter. So with the prospect of a prolonged stretch of low and stable inflation, the economic backdrop in Japan is looking better than it has for some time.

But it’s not just a macro story: there’s plenty happening in the Japanese corporate world too. Dyed-in-the-wool enthusiasts have been talking for an age about company management teams in Japan becoming more friendly toward shareholders. But it appears there are finally reasons to pay attention – the big one being the Tokyo Stock Exchange’s recent promise to penalize any firm not taking action to address its lowly valued stock price. That’s a big deal because investors love it when company management cares about the stock price – something that’s been a rarity in Japan. So, with the better macro environment and the promise of some serious management attitude changes, it’s no wonder that big hitters like Buffett are paying attention. The oracle of Omaha’s turned oracle of Osaka, and has been upping his stake in major Japanese firms all year.

🥡 Takeaways

1. Not Big in Japan: population growth.

The good times might be returning, but Japan still has a lot of heavy lifting to do to address a much bigger problem – population growth. Japan’s just seen its 12th consecutive year of population decline, and in the very long term, it’s hard to grow your economy when there are fewer workers around to do that. And the problem has only been getting worse. Japan had the lowest number of births on record in 2022 and its fertility rate recently hit a brand-new low. That leaves just one solution: immigration. Now, Japan has been notoriously reluctant to let foreigners in, but lately, there’s been a whiff of change. The country has recently relaxed its visa laws to allow foreign workers to perpetually extend their stay, and to allow them to bring family members in too. It’s a small change, and won’t get anywhere near solving the whole problem, but a taste of the potential benefits could prompt policymakers to do even more.

2. Inflation has a way of changing things.

Japanese firms are awash with cash and for the most part have little to no debt. That might sound good, but it’s actually a very inefficient way to run a business. The reason why Japanese balance sheets look this way is down to deflation. See, falling prices disincentivize spending, so cash just piles up. What’s more, borrowing is hugely unattractive when prices are falling but your debt obligations aren’t. But, if inflation is indeed here to stay in Japan, then all of a sudden, adding some debt to the balance sheet becomes a good idea – because it means prices and profits rise, but your debt burden doesn’t. Now, provided management teams don’t waste that borrowed money, debt can dramatically boost shareholder returns. Think of it this way: the bigger your mortgage, the more you make on your down payment – assuming your house price goes up, that is. That’s known as leverage – and a little bit is a very good thing in the corporate world.

🎯 Also On Our Radar

Apple unveiled its much-hyped virtual and augmented reality goggles this week. Apple superfans gave the flashy launch a rapturous reception, calling it an “iPhone moment”. But outside the Apple cult, most folks laughed at its $3,499 price tag (and maybe its ski-goggles resemblance). We’ll have to wait until next year when the Vision Pro hits Apple stores to see whether the firms’ pricing gurus have this one wrong or not.