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While much of Japan spent August fretting about the Olympics, the heat and the rampaging Delta variant, some sweated over two lines crossing on a market screen.
Summer is now over and, to Japan’s chagrin, four US tech companies are together worth more than the entire Topix index, or all 2,187 companies on the main board of the Tokyo Stock Exchange.
The TSE is in good company and the quartet behind this inflection is well known: at more than $7tn, the combined market capitalisation of Apple, Alphabet (Google), Amazon and Facebook, or GAFA, habitually mocks any juxtaposition with other companies and markets. Apple and Facebook are together worth more than the FTSE; Amazon alone is bigger than the whole of Germany’s Dax index. In this context, and in the calculus of global portfolio management, the $6.8tn Topix was merely the latest international benchmark to move from GAFA’s penumbra to full eclipse.
The surpassing of Tokyo nevertheless felt epochal — a moment, particularly for those obliged to argue ever more inventively for Japan’s investment relevance in a post-Abenomics era — to gather themselves and decide what suasions might work when the centre of gravity seems so decisively elsewhere. Built into the fear of being sidelined is the fading memory of more glorious times in the late 1980s when TSE-listed companies represented about half of all global market capitalisation and Japanese banks casually eclipsed Exxon and General Electric.
While the current performance of Japanese stocks may appear superficially healthy on its own terms (the Topix closed on Wednesday at a five-month high), the MSCI Japan index has underperformed the US and Europe by, respectively, 19 and 14 percentage points this year — or, as the brokerage Jefferies notes, close to the worst record of the past 20 years.
Even without that evidence, plenty of observers view a significant bloc of Japan’s corporate roster as deeply undervalued compared with global peers. They can see a yawning gap between earnings and valuations and have grown less certain as to what narrative or catalyst could sustainably cause it to narrow, let alone disappear.
One theory is that the sudden attachment of new and potentially valuation-crushing political risk to Chinese stocks could create a rotation of global portfolio money away from that threat and towards the visible earnings stability of Japan.
Meanwhile, despite significant vaccination levels, Japan’s prospects of a post-Covid rebound are not sufficiently entrenched as an idea to have become a clear “buy” signal.
Almost 41 per cent of Topix stocks are trading below their pre-Covid levels, as compared with 17 per cent of stocks in the S&P 500, note analysts. The spectacle of the GAFA/Topix crossover also coincides with a natural attack of post-Olympics blues: the games did not deliver the expected economic buzz and may have prolonged the pandemic’s squeeze on the economy. The situation has left prime minister Yoshihide Suga looking weak and his political future and reform agenda in doubt.
Jefferies strategist Shrikant Kale argues that all this gloom is concealing a number of signals that Japanese stocks — in part because of their underperformance this year — are primed for a roaring comeback between now and the end of the year.
Seasonal factors, which include the consistent tendency of the yen to weaken and yields on US 10-year Treasuries to rise in the September to December period, will be the strong propellant they have historically proven. In addition to those tailwinds, says Kale, Japan’s rising ratio of fully vaccinated adults — now above 43 per cent despite a late start — should trigger the kind of rally in so-called “comeback stocks” that have dominated as a theme in US markets in recent months.
Once momentum is achieved, global investors may take a closer look at Japan’s fundamentals, which according to Kale include its leading the global rebound in corporate profitability and a remarkable quarter of Japanese earnings in three months that ended in June. A record 76 per cent of Topix companies beat consensus forecasts.
The two valuation lines — of the four US GAFA stocks versus the Topix — may turn out to have crossed permanently. Many will decide that the distortion lies in the extreme valuation growth of the US leviathans: the more immediately lucrative distortion for investors may lie in the undervaluations that have fed their rise.