Episode Details

The conclusion of our two-part episode from Morgan Stanley and MUFG’s Japan Summit looks at structural shifts in Japan’s economy and Prime Minister Sanae Takaichi’s strategic growth agenda.

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----- Transcript -----

Seth Carpenter: Welcome to Thoughts on the Market. I’m Seth Carpenter, Morgan Stanley’s Global Chief Economist and Head of Macro Research. This is Part 2 of our podcast from the Japan Summit.

It’s Friday, May 22nd at 8 am in Tokyo.

I might stick with equities for just a minute, and Sho, just to dig deeper into the equity market. Jonathan expressed some of the bullishness. Anything you want to elaborate on where the real strong conviction on this positive view about Japanese equities is coming from?

And then just as a warning, I'm going to come back to you and ask, if you're wrong, where could you be wrong? Because again, I think where we add value most to clients is not just giving a clear view, but also pressure testing that view.

Sho Nakazawa: Our constructive view on Japan equities comes down to one simple point. Three structural changes are still continuing. So, the first is shifting macro environment. The combination of stable inflation and wage growth is a kind of phenomenon we have not seen, at least in my lifetime. It changes corporates and households’ behavior, especially in terms of balance sheet management.

And then secondly, the corporates profit improvements. We do not see it as a cyclical recovery. We see it as a structural change. As in the past, Japan corporates heavily relied on cost-cutting amid a deflationary environment. But today, price pass-through is improving, and the Japan corporates are becoming better positioned in growth profit in nominal growth environment.

The third is corporate governance reform. Awareness of the capital efficiency has clearly increased. We continue to see share buybacks, dividends increase, and a portfolio restructuring as well. And on top of that, the Takaichi administration has made growth investment and crisis management investment as well.

Of course, the Middle East situation is a source of noise. But structurally is a supporting factor for Japan equities secular bear market, which is a view Jonathan has held for very long time, has actually becoming stronger.

But let me say that if I'm wrong, maybe I should be more bullish. In fact, the two key drivers here, if we assess the bear case scenario on Japan equities…

So, one key driver should be the upside come from the investors constructive view on the Japan fiscal efficiency. And on a micro level, the corporate behavior changing faster than market expects. If we assess the recent rise in long-term yields, it reflect the concern to the Japan fiscal position and that BoJ behind the curve.

It would weigh on the Japan equity valuation because it raises cost of capital and it weighs on the Japan equity valuation. But on the other hand, [the] Japanese government will disclose its basic policy in June. And if it could include a credible plan to improve Japan’s fiscal positions, perhaps under Japan version of DOGE, which is led by Financial Minister Katayama-san, I think it could alleviate the excessive concern toward the Japan's fiscal position, and it [could] lower the cost of capital on Japan equities.

You know, micro level, the corporates behavior is already changing, as I mentioned. But there's still plenty, you know, space for Japan corporates to utilize non-cash generating assets such as cash and deposit, which is equivalent to 60 percent of GDP. The ratio is far higher than our global peers.

So, if Japan corporates move further to capital efficiency or portfolio restructuring or use some excess capital, I thi