Japan: Tokyo Stock Exchange

I have been looking forward to my visit to the Tokyo Stock Exchange with great anticipation.  The exchange went completely electronic in 1999, so there is no activity associated with historical exchanges.  This did not dim my enthusiasm to be at one of the key financial hubs in the world. (The Tokyo Stock Exchange by some measure is the world’s third largest exchange by trading volume and by aggregate market capitalization.)

I met with Shun Takato and Goki Sakaguchi.  They shared valuable insights about Japanese markets.  They repeated three things that seemed to be on the lips of every Japanese professional that I spoke with: Abenomics, the Bank of Japan’s aggressive policies, and improved corporate governance.

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The chart to the right shows increased trading volume with the election of Prime Minister Abe in December of 2012.  The Bank of Japan announced that they would buy ETFs back in April of 2013, and they announced in October of 2014 that they would buy even more!

They pointed out that Prime Minister Abe and Central Bank Governor Kuroda are speaking directly to the markets.  This is a big change and it is stimulating the economy in a positive way.

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Abenomics are positively impacting the ETF market.  In addition, margin rules were relaxed within a few months of Abe’s election.  This has led to a surge in leveraged ETFs, and leveraged ETFs account for more than 70% of ETF trading volume.  It is not unusual for the security with the most daily volume on the Tokyo Stock Exchange to be a leveraged ETF.

While a weaker Yen has been positive for Japanese corporations, it was their belief that this matters less and less.  Companies are global, and factories for many of these companies are overseas (a continued theme).

Shun and Goki highlighted significant changes in corporate governance.  This has been a significant focus and emphasis of Prime Minster Abe’s government. 

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These global standards of corporate governance are making Japanese companies more attractive to foreign investors.  Past perception has been that Japanese corporations have not been well governed—this is changing.  (The Japanese Kieretsu system has dominated Japan for a half century—this is a series of interlocking relationships and cross shareholding that insulates a company from some market forces.  While this contributed to economic growth, in some cases it has also shielded companies from efficient behavior.)

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Government entities that are major owners and purchasers of the stocks like the Bank of Japan (BOJ), and the Government Pension Investment Fund (GPIF) are focusing on asset managers and companies with better governance.  The GPIF target allocation to Japanese equities has doubled since October of 2014. (Government buying has had a significant impact on financial markets.  This is expected to continue).

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Improved governance is sparking “smart beta” investing in Japan.  The new JPX-Nikkei 400 index focuses on key fundamentals and governance, and it is used as the benchmark for the BOJ and GPIF.  Some are referring to this as the “shame” index, because companies not included are shamed for their lack of high standards.  It is creating pressure to be included.

The discussions at the Tokyo Stock Exchange were very valuable.  There is clear enthusiasm for Japanese equities that has not existed in many years.  It was very illuminating to visit the museum as I left the exchange.  (sorry about the dark, poor quality picture).

This display greets every visitor as they enter the museum.  It shows that the Japanese stock market is roughly half of its peak in 1989.  Think about the repercussions of this—an entire generation of investors has not seen or experienced that stocks make money over the long-term.  Can you imagine the impact?  Is there any wonder that Japanese individuals park huge savings in banks with tiny interest rates?  At least the money was not lost!  Can you imagine the impact if Japanese investors actually believed that making a long-term allocation to Japanese stocks would make them an attractive return?

Things are clearly changing in Japanese financial markets.

Special thanks to Brennan Staheli, Joe Dunbar, and the Lunt Capital team for their contributions to this report.