The Bank of Japan’s Governor Kuroda said to parliament on March 5th that there is no need to widen the band set for its long-term yield target, as

This underlining of a stable monetary policy will help continue the progressive recovery of the Japanese economy following the shock the COVID-19 pandemic dealt the economy and its effects on the global economy. In the current quarter, production and trade are holding up well, supported by strong foreign demand and a robust manufacturing sector. However, declining consumption and services due to the COVID state of emergency mean that GDP will likely register a mild decline in the quarter. The economy is expected to return to positive growth in subsequent quarters with the eventual lifting of the emergency restrictions, the rollout of vaccines, supportive fiscal and monetary policies, and a strengthening of foreign demand boosted by the fiscal stimulus in the US and accelerating growth in China.

Last week, Prime Minister Yoshihide Suga announced that the COVID state of emergency for the Tokyo metropolitan region will be extended another two weeks because the situation has not improved sufficiently to end the restrictions. This extension will delay a bit of the economic recovery. Japan has been slower than most other major economies to unroll its vaccination program. However, overall, Japan has dealt with and weathered the pandemic relatively well, as have a number of its Asia-Pacific neighbors. It ranks 38^th globally in its total number of cases, with only 8,178 deaths. Japan’s cases per million of the population is just 3,469, compared to 89,233 for the US, 61,844 for the UK, 29,808 for Germany, and 15,034 for the world average.

Following the 5% slump in the Japanese economy last year, the projected GDP growth in 2021 is 2.6%, followed by a similar advance in 2022. While such growth rates look modest compared to the average growth of most other advanced economies, they will be more than three times Japan’s average growth rate of 0.72% over the preceding 2010–2020 period. The growth of Japan’s economy, the globe’s third-largest as measured by nominal GDP, is limited by demographic headwinds, namely a projected 30% decline in the working-age population over the 2020–2030 period. This decline can be offset to some extent by increasing labor force participation. Increased immigration would also help but is not favored thus far. Chronically weak demand, worsened by pandemic restrictions, has also been a limiting factor.

On the positive side, the economy has a robust industrial sector, accounting for some 30% of GDP, concentrated now in high-tech fields – machinery, electronics, manufacturing, automobiles, transportation, chemicals, and metals. Japan’s industries are imbedded in Asian supply chains, producing goods in the high end of the value chain. China and the US are Japan’s two largest export markets. Japan’s service sector, which accounts for 69% of GDP, has been the fastest-growing part of the economy over the past four decades. Leading service fields are finance, communications, information, and transport. Services sector activity has contracted amid ongoing pandemic restrictions; however, firms in the sector have indicated they have become increasingly confident that business conditions will recover in the coming months.

The Japanese stock markets have performed well over the past decade and have definitively outperformed over the past 12 months up to March 5^th. The Nikkei 225 index gained 35.3% on a total-return basis, compared with 27.1% for the S&P 500 in the US and 15.5% for the EURO STOXX 50 in the Eurozone. If we look at the returns to US-based investors who are using ETFs to invest in the Japanese and European markets, the iShares MSCI Japan ETF, EWJ, gained 29.6% over the past year; and the iShares MSCI Eurozone ETF, EZU, gained 21.51%. The differences are due to both exchange rates (the yen weakened and the euro gained relative to the US dollar over the period) and to the MSCI indices tracked by the ETFs.

Last month at the peak of the stock market rally, the Nikkei 225 Index reached the 30,000-yen mark for the first time in 30 years, easing back to 28,864 by March 5. Attaining this landmark sparked concerns, as 30 years ago Japanese stocks were clearly in a bubble that eventually burst. The concerns are understandable. There clearly is some froth in global equity markets and considerable uncertainty driven by the pandemic. Financial markets are once again highly accommodative. However, there are important factors that reassure us about the prospects for Japanese equities. An important difference this time is that, with its inflation target of 2% likely to remain out of reach for the foreseeable future, the Bank of Japan is very unlikely to alter its very easy monetary policy in 2021 or 2022. As noted earlier, we expect a robust recovery in the economy beginning in the second quarter, gaining pace in the second half, and continuing in 2022.

Also, the corporate sector is in solid shape according to the Ministry of Finance’s corporate statistics report for the fourth quarter of 2020. Corporate sales and profits were improving, particularly in manufacturing. Another difference from the previous bubble period is that there are no indications of overly optimistic growth expectations leading to a buildup in excess capacity.

Japan’s corporate governance reform should also be noted. In 2018, the Japan Exchange Group revised Japan’s Corporate Governance Code to encourage more sustainable corporate growth and increased corporate value by, among other things, lowering the large proportion of cross-shareholdings by firms. One sign that this reform measure is helping to encourage capital inflows is the $6 billion Berkshire Hathaway invested in five Japanese trading companies last August. Changing corporate governance significantly, however, will take time, as it requires a change in culture.

Among the twenty US-listed ETFs options for investing in Japan’s equities, the iShares JPX-Nikkei 400 ETF, JPXN, selects companies based on metrics that measure efficiency in the use of capital and profitability as well as qualitative factors such as governance and reporting standards. Over the past 12 months, JPXN returned 29.4%, essentially the same as EWJ did. The Xtrackers Japan JPX-Nikkei 400 Equity ETF, JPN, tracks the same index; and its expense ratio is only 0.09%, compared with 0.48% for JPXN and 0.51% for EWJ. But JPN’s assets under management thus far total only $16.6 million, much less than is the case for the other two ETFs. Yet its etf.com implied liquidity measure is 4 in a 1–5 range, the same as for JPXN. The measure for EWJ is 5.

We continue to maintain the Japan ETF, EWJ, positions in our International and Global ETF Portfolios.