Japan musings
Reality check from the "Japan Optimist"
I recently enjoyed reading the article below by
AKA the “Japan Optimist”. As with everything Jesper writes, it’s always thought-provoking. If you haven’t already, I recommend subscribing to his Substack.
Jesper’s article led me down a rabbit hole of thoughts. I’ll highlight some interesting quotes from his piece, while also adding some of my own thoughts along the way too.
To distinguish between the two, all quotes by Jesper will be bolded, while my own thoughts will be in italic. This not only gives proper credit to Jesper’s original work, but also makes it clear which takes come from a seasoned expert and which come from a rambling parrot.
“Make no mistake: Japan has become a ‘trust fund babe’ or rentier economy (living off the assets accumulated by the previous generation…). Japan is no longer an export powerhouse.”
I never heard anyone describing Japan as a “trust fund babe” which I thought was true and hilarious…
Ok getting into the more serious stuff…
“The Yen has collapsed by 80% since the start of Abenomics in 2013 and is now weaker than it was in the late 1960s, ie. before Breton Woods (according to Bank of Japan calculations of that the real effective Yen). Japan’s exports should be booming…but are not. Or put in another way, the Yen is still not weak enough to boost Japan’s exports.”
In other words, Japanese exporters have lost competitiveness faster than they’ve benefitted from a much weaker yen. This raises an unsettling question: over the next decade, if the yen stays the same or strengthens, are we going to see an accelerated decline in Japan’s export competitiveness? Kind of a scary thought, isn’t it? The one-two punch of lower US interest rate + stronger yen could also reduce Japan’s “trust fund income” from abroad.
A stronger yen seems to be what most people in Japan want nowadays, with inflation and rising cost of living top of mind. But be careful what you wish for? It seems there is no easy answer…
“Made-in-China competition is real”
“It is hard to imagine - even for the Japan optimist - that the Japan moat in the specialized and precision machinery sectors can be defended forever: China spends more than 3-times on Research and Development than Japan, US$500 billion versus US$150 billion; and China is reported to have more than 6 million people working full-time in R&D, compared to an estimated 710,000 in Japan.”
“Make no mistake: true Made-in-Japan global champions - robot maker Fanuc, factory automation giant Keyence, electronic component powerhouse Murata, to name but a few Japan superstars - are feeling the heat from made-in-chinas relentless rise in overall competitive power. It’s no longer just price. The gaps in quality of manufacturing, quality of after-sales servicing, and qualitative innovation are narrowing fast. Japan knows full well that China is an awe inspiring competitor.”
I actually wish these quotes were not from Jesper, but from Japanese management instead. Because you see, I think a big challenge that investors face is that management teams are never forthcoming regarding the extent of Chinese competition. I’ve heard Japanese management (equally applies to US/European management) blame interest rates, inventory cycle, war in Ukraine, weather… anything except the Chinese companies directly eating their lunch. This has happened long enough that I’ve stopped asking them at all. The only option is to do your own research and manage exposure properly.
Rather than betting on Japan competing and winning against China, I’d rather bet on areas where Japan has no competition (why would you want to fight such a hard battle)? I’ve been deploying more capital over the past year into Japanese software (SaaS), defense, and beneficiaries of in-bound tourism.
“U.S. protectionism - or the threat of it - will turbo-charge the trend of Japan’s loss of global market share and competitiveness in non-US markets. Why? Because U.S. protectionism will further aggravate China’s excess capacity - China must keep producing to keep employment, but will lose U.S. customers. The net effect will almost certainly force de-facto dumping of Made-in-China consumer- and capital goods onto the world in general, the Global South in particular.”
One of the biggest tests facing Corporate Japan over the next decade, in my view, is how they will defend Southeast Asia which is their golden goose. Southeast Asia remains the most “moated” and attractive region for Japanese businesses, in a world where neither China nor the US are easy places to operate in (next time you are visiting Thailand or Indonesia, count how many commercial trucks are Isuzu or how many passenger cars on the road are Toyota. Then walk into a convenience store or try going into an upscale mall).
Southeast Asia will be a key battleground, a showdown between entrenched Japanese interests and aggressive Chinese challengers. If Japan loses Southeast Asia, I think it’ll be a permanent liver blow to Japan, one it will have a hard time recovering from. But that’s exactly why Japan will fight fiercely to defend its position…
“…human capital has been accelerating consistently for over three years now; and more generally, the pick-up in Japan’s corporate metabolism — record M&A, MBOs, IPOs, spin-offs and buyouts — is poised to deliver a more efficient and productive domestic industrial structure.”
Jesper seems most optimistic on what he calls the rise in “corporate metablism”. This has been my own focus as well, looking for companies with a long runway to improve their metabolism.
Some ideas to chew on:
Shareholder register: Avoid large controlling shareholders. The opportunity cost is too high since activists or strategic buyers can’t easily get involved. Even with family ownership, it needs to be small enough for management to be vulnerable.
Which companies have underlying businesses that are proven to be good, that could significantly re-rate if they just got their acts together?
Conglomerates pursuing selection & concentration. A record number of PEs have entered Japan in recent years (and these guys need to do deals to earn their paycheck). Can this accelerate the trend of Japanese companies shedding their non-core assets?
Investors love flocking to industry leaders. This can create massive valuation gaps that are hard to justify between the #1 in the industry and the rest. If the “underdogs” demonstrate a willingness to improve, there’s ton of upside. When the stock price of your rival goes up 5-10x, it becomes increasingly difficult for the laggards to just sit still and do nothing (capital markets pressure + exposed to being activist/takeover target)
I have been looking for opportunities at the intersection of these ideas. I hope to share them with you guys soon.
I have always wondered if the JPY-USD exchange rate should move to 200:1. Yes the energy import cost will rise a lot, but a better relationship with Russia and more R&D can help on the nuclear power side. Selling more into the ME is also possible. Japan may not be quite a society of trust fund babes, but Japanese TV dramas are full of stories of good, but perhaps not top-notch young people forced into crimes or suicides due to failed small businesses or mobs or high living expenses. Japanese government has made the usual mistake of concentrating too much spending in the greater Tokyo area, or the Kanto-plain in general. But the Tokyo area is too expensive for the younger generation. So many Japanese companies have exported jobs to China and not moving them back. The net effect is young people lose faith in a bright future. The same can be said in SK, China, and Taiwan. I suspect HK and Singapore are in the same boat. These young folks have little future until the older generation dies out and the overall population drops down. But then there is the rising problem of robotics and imported labor.