Takaichi Raises Japan’s Wall of Worry

Stock market coverage is a funny thing. It hypes the Magnificent Seven as if they are the only thing driving returns, yet they are underperforming this year. It implies your investment choices are either AI-heavy Tech stocks or janky small companies. And it ignores the vast universe of global stocks, as if US investors should only own American companies. But there is a big ol’ world out there, with a bigger wall of worry than America’s for stocks to climb. Like Japan.

Earlier this year, Japanese sentiment was heating up, maybe a little too much. Prime Minister Sanae Takaichi had just won a surprising supermajority in a snap election, clearing the way for her to enact her economic agenda. Expectations were hot, and the risk of disappointment if intraparty gridlock got in the way was creeping. Debt fears helped put a brake on this, but it was a sentiment crossroads.

Now? Not so much. The weak yen continues roiling headlines, as do debt fears and rising yields. Pundits blame Japanese stocks’ pullback since mid-June on all three, as well as Takaichi’s new investment plan. They warn it is $2.3 trillion in unfunded public investment commitments and a blueprint for strongarming the Bank of Japan into doing its bidding. Parallel reforms to Japan’s corporate governance code allegedly undermine shareholder returns and make companies a state investment tool. It all sounds bad … but we think it is a giant kettle of false fears.

Let us start with the allegedly unfunded public investment boondoggle, which headlines inevitably called a Liz Truss special.^[i] It targets ¥370 trillion ($2.3 trillion) in new investment in 17 strategic sectors over the next 14 years, with a focus on AI, semiconductors, shipbuilding and defense industries. Because it did not include a specific, detailed government funding mechanism, commentators globally shorthanded it as $2.3 trillion in deficit spending.

Only, it isn’t. It is all about joint public and private initiatives. That is a huge spectrum, folks. It could mean more investment tax credits, expensing changes and the like to encourage more private outlays. It could mean government pension fund reform to direct more money to Japanese stocks. It could mean “Buy Japan” incentives in tax-advantaged investment accounts. Or other incentives for Japanese investors to shift from foreign stocks to domestic. It could be programs to boost bank lending to companies to fund investments. The possibilities are near-endless.

Regardless, while $2.3 trillion is a big number, spread over 14 years, it is about $164 billion annually.^[ii] We fail to see how $164 billion in public-private partnerships, however they look, will bankrupt a $4.4 trillion economy.^[iii] More likely, all this stuff goes gradually and investment totals miss the target. But again, these aren’t public spending plans. They are loose estimates of the level of investment the government would like to see. Overall targets for investment from all sources.

Which is where the corporate governance reforms come in. To the extent these are getting coverage, it is pretty dour. Commentary casts them as a U-turn from the late Shinzo Abe’s reforms, which were part of his plans to make the conglomerates known as keiretsu more accountable to shareholders. These have gradually borne fruit, attracting more activist investors aiming to unlock higher returns. But the government saw room for improvement, arguing companies focused on short-term returns at the expense of long-term investing. That is a familiar gripe globally, and it is partly behind the SEC’s plans to make quarterly reporting optional in the US.

Japan is taking a different tack. The Tokyo Stock Exchange and Financial Services Agency are proposing to amend the Corporate Governance Code to encourage risk-taking and a focus on longer-term returns. Basically, they are worried companies relied too much on dividends and buybacks to meet return on equity targets, and they want more capex instead. The Ministry of Economy, Trade and Industry (METI) notes dividend payouts tripled in fiscal 2013 – 2024, with stock buybacks more than quintupling, while capex and research & development spending remained flat relative to sales.^[iv] So they are saying hey, Japan Inc., try actually investing for long-term returns please.

This all seems innocuous to us. The proposed code doesn’t ban buybacks or dividends. It just steers focus a little. Japanese companies are still getting used to actually having to deliver returns and be accountable to markets. Before, they all owned stakes in one another, making the central holding company the primary source of accountability. Shareholders and returns were second-fiddle. Not anymore, and regulators are trying to address the growing pains. Their proposed revisions simply put an emphasis on substance over style. Here, too, we think the fear overshot.

Weak yen and debt fears also go too far, as we have covered before. In reality, Japan’s stocks are down in sympathy with the broader semiconductor downturn, and Japan’s yields are up with global yields. As for the kerfuffle about the Bank of Japan’s independence, Takaichi’s plans just extend the status quo. The BoJ has a statutory requirement to coordinate with the government and aim for monetary and fiscal policy alignment. The new budget plan simply reminded everyone involved of this while nodding to the BoJ’s statutory independence.^[v] Nothing is changing, making this look like yet another false fear.

Stocks move on the gap between reality and expectations. False fears are bullish because they lower expectations unnecessarily, widening that gap. The bigger the gap, the more positive surprise potential there is, which is why the old saw says bull markets climb a wall of worry. The bigger the wall, the more room there is for stocks to climb. Japan’s wall, it seems, is quite big.