The New Japan Trade

Added: 2026-05-23

[00:00:00]Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research. This is part two [music] of our podcast from the Japan Summit. It's Friday, May 22nd at 8:00 a.m. in Tokyo.

[00:00:17]I might stick with equities for just a minute and and show just to dig deeper into the equity market. Jonathan expressed some of the bullishness.

[00:00:26]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?

[00:00:40]Because again, I think where we add value most to clients is not just giving a clear view, but also pressure testing that view. 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.

[00:01:14]And the secondly, the corporates profit improvements. We do not see it as cyclical recovery. We see it as a structural change. As in the past, Japan corporates are heavily relied on cost cutting, I mean a deflationary environment. But today, price pass-through is improving. And the Japan corporates becoming better positioned in growth profit in a 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.

[00:01:53]And on top of that, the Suga administration has made growth investment and crisis management investment as well. Of course, the recent Middle East situation is a source of noise, but uh structurally it is supporting factor for Japan equities secular bull market, which is a view Jonathan has held for very long time, has actually becoming stronger.

[00:02:18]But let me say that if I'm wrong, maybe I should be more bullish.

[00:02:22]>> [laughter] >> As um in the the two key drivers are here for if we assume the bull 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 the on a micro level, the corporate behavior is changing faster than market expects.

[00:02:46]If we assume the recent rising long-term yields, uh it'll reflect the concern toward the Japan fiscal position and that BOJ behind the curve.

[00:02:57]It would weigh on the Japan equity valuation because it raise the cost of capital and it weighs on the Japan equity valuation, but the on the other hand, Japanese government will disclose its basic policy in June.

[00:03:12]And if it could include a credible plan to improve Japan fiscal position, perhaps under Japan budget of dodge, which is led by financial minister Katayama-san, I think it could alleviate the excessive concern toward the Japan fiscal position and it lower the cost of capital on Japan equities.

[00:03:32]You know, micro level, the corporate behavior is already changing as I mentioned, but there's a still plenty of space for Japan corporates to utilize non-cash earning assets such as cash and deposit, which is equivalent to 60% 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 think there should be additional room for Japan equity market to re-rate higher.

[00:04:05]All right. So, if you're wrong, it's insufficient bullishness. That's >> [laughter] >> a good place to be. So, Koichi, Jonathan and Sho are bullish on equities. And so, do you expect big shift in capital flows? And would that drive further appreciation of the currency? How do you think about the global investors' view of Japan and what it means for capital flows on the one hand, and the value of the currency on the other? As for the uh capital flows, I think the under this reflationary regime is what's the notable change among the Japanese financials, uh that they are shifting away from the fixed income products. I mean, like JGBs.

[00:04:46]Given the current attractive yields, you may be wondering why the banking sectors buy the JGBs. But, according to the recent disclosures, they have not purchased the JGBs much.

[00:04:59]Because the uh their lending activity performed very well. So, as for the uh their lending activity have been performed well, they have no incentive to like make money in the securities investment.

[00:05:12]You know, the uh the their lending activity have accelerated thanks to the uh corporate capex investment to improve the productivity amidst the labor shortages in Japan. Once the uh the banking sector starts to see some slowdown, or some symptom of the lending activity to slow down, in such a case, they uh quickly shift to the securities investment, and the JGB market will change the bonds. But, the uh so far, you know, like a lending growth uh accelerated much. You know, the April like lending growth is around 6% on the year-over-year base, very strong. So, I think the the banking sector still not have incentive to buy the JGBs.

[00:05:57]As for the lifers, lifers case is much more serious, I think. Because of the the younger ages shifting towards the equities to defend the asset, particularly under the new NISA scheme where it was launched in 2024.

[00:06:15]The younger people basically like allocate their assets to their equities rather than their saving type of the product. Which means that they are the lifers are struggling to make uh together the new monies. And this means that the their demand for the longer JGB to shrink.

[00:06:32]And the Japan lifers already already filled the duration mismatch by 2023 to prepare for the new regulations starting from this fiscal years. Unfortunately, the they already finished the duration mismatch uh type of the operation by 2023.

[00:06:51]But they will the either going to up from the 2024 thanks to the BOJ's normalization.

[00:06:58]So, under such conditions, they are now struggling to the high market market loss on the longer JGBs. And the some like lifers are now facing to the impairment loss accounting. That actually becomes lifers are net seller of the longer JGBs rather than the the buyers.

[00:07:18]Okay, super helpful. Okay, we focused a lot on near-term developments, the energy shock, first quarter GDP, but we can think about a longer-term growth scenario. And there I think AI comes in at times. Chad, you've talked about the near-term super cycle, and I think there's a near-term aggregate demand side to AI, but over the longer term maybe it's more supply.

[00:07:40]When I think about where growth is going though, I also think about shifts in the strategy for policy. So, maybe Amaguchisan, you can talk to me a bit on your take uh Prime Minister Takachi's policies.

[00:07:54]What do we think is likely to get announced? When? How do you see it affecting the the long-term growth outlook for for Japan?

[00:08:02]Japanese government publishes growth strategy report and the basic policy on fiscal management or honebuto policy in June every year. But, I think that this year's, you know, the documents will be pretty important because these are the first documents under the Takachi administration. And these documents will set the direction of, you know, economic policy by Takachi-san, Sanae Takachi, so or Sanaenomics.

[00:08:28]I think compared with Abenomics, Takachi-san focuses more on the supply side issues, you know, supply domestic investment. While, you know, Abenomics, you know, focused more on the exit from deflation, focusing on demand-side policy, particularly, you know, monetary easing. In the growth strategy report, the focus will be a strategic investment in 17 strategic areas, including AI, especially, you know, AI robotics, semiconductors, defense and space, cybersecurity, and content industry, and so on. Another important point of, you know, Sanaenomics is that there's overlap between these, you know, strategic investment areas and national securities. The government will also update its defense strategy by by the end of this year, and there'll be a increase in the defense budget target.

[00:09:20]The focus will be a lot on, you know, I think a dual-use technologies, and also, I know, resilience of supply chains going ahead.

[00:09:29]Another important point is that I think uh there'll be a change in the the budget formation process. I think under deflation, there's a effectively you know cap on non social security spending and but I think this government will likely allocate budget you know for multi you know investment. So I think the budget process will be more flexible and they put more emphasis on the initial budget rather than the supplementary budget. So I think these these documents will be pretty yes important. Yes. To to monitor going ahead but overall I think the government you know yes they they do care about the you know market conditions.

[00:10:13]They will likely avoid you know massive you know expansion but I think a slight you know expansion especially in the area of you know strategic investment is likely to happen. Very very helpful.

[00:10:26]All right.

[00:10:27]That's the end of the panel. Thank you very much to my colleagues and this is where I have to shift back into podcast mode to say thank you for listening and if you enjoyed thoughts on the market please share it with a colleague or friend today.

[00:10:42]Thank you very much everybody.

[00:10:45]>> [applause] >> The preceding content is informational only and based on information available when created. It is not an offer or solicitation nor is it tax or [music] legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.