Who Will Buy Japan?

The yen’s rapid fall may bring deep-rooted change and rising returns

Currency markets move in the direction of maximum pain. I received this insight from one of the most successful currency-market speculators in recent history, the leader of the team that broke the Bank of England 20 years ago, on September 16, 1992.

Now that yen depreciation is accelerating toward my ¥150–160 to the dollar parabolic overshoot target, outlined in the spring 2022 issue of The ACCJ Journal, it is worth thinking about where the maximum pain threshold might be, and what forces will arrest the yen’s fall from grace. Who will buy Japan?

Land of Bargains

It is now very easy to demonstrate that Japan is cheap:

• A Big Mac costs ¥390 in Tokyo versus $5.50 in Los Angeles, making your dollar’s purchasing power double this side of the Pacific
• Japanese labor costs are down to $33,000 per year on average, less than half the $69,000 payout in the United States
• A Tokyo-based software engineer now comes about 30 percent cheaper than one based in Ho Chi Minh City, Vietnam
• And at ¥150 to the dollar, a nurse in Manila would earn more than one in Tokyo

Importantly, even without the exchange rate, Japanese companies are cheap, with 49 percent of listed companies trading below book value, their assets worth more than what you must pay in the market to buy them.

Japanese companies trade on a 12-times price-to-earnings (PE) multiple, which is cheap compared with the 24-times PE multiple commanded by those in the United States.

When buying Japan Inc., you basically earn back your investment in half the time—corporate earnings alone will let you recoup your investment in just 12 years in Japan, while you must wait 24 years in the United States. So, the costs of buying and operating productive assets has become very attractive in Japan.

Land of Opportunity?

Where, exactly, are the opportunities, and who will seize them? Here it gets interesting because, in my view, the forward-looking dynamics are poised to force much more deep-rooted change than old-style models of inward investment would suggest.

This is because the coming investment wave will be primarily in the service sector, not the industrial or manufacturing sectors.

Clearspeak: neither Japanese nor global manufacturers will begin to build significant new factories or add production capacity here in Japan. Against this, all aspects of the domestic service sector are poised for an unprecedented investment boom.

Why? For manufacturing, labor costs are an increasingly minor factor in deciding where to build a factory. Much more important is proximity to market, proximity to suppliers, and full end-market reach. Moreover, national economic security forces an additional steep discount on produce-for-export strategies. Specifically, recent US legislation has made it uneconomical for global carmakers to compete in the US market unless they produce onshore. The new subsidies and incentives to redirect energy and environmental consumer preferences in the United States dictate as much.

“When buying Japan Inc., you basically earn back your investment in half the time—corporate earnings alone will let you recoup your investment in just 12 years in Japan, while you must wait 24 years in the United States.”

To wit, within mere weeks of US President Joe Biden’s new economic policy bill having been passed, both Honda and Toyota, as well as electric-vehicle battery maker Panasonic, announced plans for new US-based production sites and research-and-development facilities totaling more than $15 billion. All this to ensure that their “made by Japan” products are eligible for the new US industrial and consumer-policy incentives. I have no doubt that the industrial onshoring wave in the United States is only just beginning.

In contrast, Japan’s service sector is poised to be swept away by its own wave of onshoring. Unlike in manufacturing, labor costs are a dominant factor driving service companies’ performance. And here, Japan has become cheap and, now, has a competitive advantage. Watch for a pickup in direct investment, with more global service giants buying into Japan following PayPal’s $2.4 billion acquisition of Tokyo-based startup Paidy last year and the growing success stories of Salesforce, Inc., Amazon Japan G.K., Yahoo Japan Corporation, Google G.K., SAP Japan Co., Ltd., Aman Resorts Ltd., and law firm Morrison & Forester LLP in Japan, to name but a handful.

All said, I am very much looking forward to seeing more and more US and global service companies buying into and expanding business here in Japan. Most important, developing a service business in Japan has become more attractive than ever, labor market mobility having increased greatly, primarily because the pandemic has freed many from traditional corporate loyalties and unlocked a quest for better opportunities and higher pay. Potential employees are available, cheap, and motivated.

Zombie Killer

What does this have to do with the yen? Well, if I am right and global investment in Japan starts to pick up, this is one potential source of demand for yen. However, in the end, it will always be Japanese investors who hold the key to the yen’s fortunes. Japan is, after all, the world’s largest creditor nation, so where Japan invests matters.

So far, Japanese investors have not been investing in their own markets. They will only do so if and when Japanese domestic companies present credible business plans and productive investment strategies. Clearly, Japanese investors do not believe the value proposition outlined above, namely, that half the companies are trading below the value of their assets. They think the assets are underutilized, are not sweated hard enough, and that Japan is a heaven for zombie companies rather than a breeding ground for corporate excellence and best-in-class performance.

Can Japanese Prime Minister Fumio Kishida’s new capitalism deliver the end of zombie capitalism? There is no question that, since the end of the bubble economy in the early 1990s, Japan’s model of capitalism has become increasingly focused on providing more-or-less-free capital in a bid to shelter local companies from the forces of asset deflation, technology-induced disruption, rising capital costs, and other forces of creative destruction.

Twenty years on, rather than having global top performers, the result is a capitalism marked more by zombie companies that drag down industry, macroeconomic performance, productivity, and financial returns. This is where Kishida’s promise of a new capitalism could have real meaning.

If new capitalism marks a departure from zombie capitalism, and actually seeks to incentivize sector-by-sector industrial reorganization and streamlining, then prospects for a true productivity-led growth spearheaded by the service sector come into sight. The combination of global entrepreneurs wanting to seize unprecedented attractions and opportunities offered by Japan’s domestic service sector, combined with domestic political capital invested in accelerating the long-overdue consolidation and reinvention of local service providers, could be an incredible force for future prosperity.

I know this is a big if, but let’s give optimism a chance.

Clearspeak: if the current pain of yen depreciation feeding cost–push inflation delivers both long-overdue industrial reorganization and the emergence of true Japanese service-sector national champions, Japan’s investors will be rewarded handsomely. This will be not just from a tactically expedient increase in yen equity allocations because, say, the United States enters a recession, but from a strategic Japan overweight position, where yen companies deliver rising returns based on, yes, the domestic service sector.