1. Japan – Changing Attitudes

    Fourth Quarter 2017
  2. Japanese companies have a history of resisting change but then adapting quickly once consensus has been reached. We saw this in 2011 when businesses worked together to cut energy consumption after the Great East Japan earthquake and more recently with the rapid adoption and compliance with Japan’s first corporate governance code. We believe consensus is now beginning to emerge on the need for serious labour market reform and the likelihood that Japan can finally escape deflation. We expect these areas to be major themes in 2018 and beyond.
  3. Changing labour markets

    Much has been written in recent months on the tightness of Japanese labour markets. The unemployment rate has now fallen below 3% and the ratio of open jobs to applicants has risen to 1.56 – its highest reading since 1974. Perhaps more importantly, the ratio of permanent job offers to applicants has risen above one for the first time; having been 0.5 just four years earlier.

    Government policy promoting work style reform could further reduce the potential size of the labour pool. A restriction has been placed on the number of overtime hours worked and there have been various initiatives aimed at changing the nation’s culture of long hours and encouraging an improved work-life balance. These have included the promotion of a monthly ‘Premium Friday’ when employees are permitted to finish work early, and the encouragement of full time workers to use their annual leave entitlement. Furthermore, in December, the government set a target of doubling the rate of labour productivity growth through a combination of tax incentives and deregulation.

    As labour shortages become more acute and widespread, a ‘light bulb’ moment is occurring among business leaders: hiring, retaining and developing good quality personnel is fast becoming a priority. Earlier this year, full time employment began growing faster than part time as business leaders sought to reduce staff turnover and recruitment costs. During our meetings with company management we have observed an increasing focus on improving staff productivity, which often lags that of similar businesses listed elsewhere. Companies are beginning to invest more in learning and development, seeking to raise engagement levels through better communication and taking steps to improve the working environment.

    Japanese Employment

    Source: Ministry of Public Management, Home Affairs etc. Data to end October 2017.

    So far, we have gained direct exposure to labour market tightness by investing in leading staffing business Temp Holdings, which benefits from rising part time wages and higher levels of job mobility through its executive search subsidiary Intelligence. Recognising that Japanese employment culture is at an early stage of change and modernisation, we are now turning our attention to business models which offer solutions that raise productivity and employee satisfaction levels. Additional work will take place in this area in the coming months.

    More broadly, we believe that our portfolios’ significant exposure to labour saving automation and capital light, online, business models position it well for an environment in which labour remains in short supply and productivity improvements are prioritised.

  4. …hiring, retaining and developing good quality personnel is fast becoming a priority.
  5. Emerging inflation

    Increasing evidence is emerging that Japan may finally escape its long-standing deflationary predicament. Wages are rising steadily, and expectations are for this trend to continue, as labour shortages remain an issue. A recently announced tax break, lasting for three years, for companies which hike regular wages by at least 3%, as well as increasing capital expenditure, should prove helpful.

    During the past year, we have also seen companies operating across a broad spread of industries putting prices up, many for the first time in decades. Leading Izakaya (Japan style pub) chain Torikizoku increased the price of its yakatori (chicken on skewers) based snack by over 6% – the first price rise for 28 years. Logistics firm Yamato Transport turned down business from Amazon owing to staff shortages, and subsequently renegotiated terms at a higher price. Both Universal Studios and Tokyo Disneyland have raised ticket prices. There are a number of other examples and corporate projections in the Tankan survey of business sentiment point to rising inflationary expectations.

    Corporate Projections for Output Prices (% annual change)


    Source: BoJ Tankan.

    Mickey Mouse greets guests during their ‘Coming-of-Age Day’ celebration at Tokyo Disneyland.
  6. Shoppers at the Don Quijote’s central branch store in Tokyo. © Yuya Shino/REUTERS.
  7. Sceptics may point out that consumer price inflation (CPI) remains anaemic and there have been other periods during the past two decades when various indicators have predicted inflation which has subsequently not been realised. This time it may be different, however. Private consumption is on a stronger footing and wage growth should allow this to continue; Japan’s output gap has turned positive and is widening; and we are detecting a genuine mind-set shift among management teams.

    Our growing confidence in the sustainability of inflation is reflected in recent trading activity. During the past quarter we added to positions in financials, favouring businesses which are likely to gain most from interest rate rises and increasing values of real assets. This includes Sumitomo Mitsui Trust, which wholly owns a significant asset management firm that stands to benefit if domestic investors shift into equities, and Dai-ichi Life Insurance, which has liabilities that are longer duration than its assets. We have also built up larger positions in real estate, observing that land prices and rents are rising, demand for office space is strong and valuations are compelling. Here, we have favoured Tokyo Tatemono and Mitsubishi Estate; both of which benefit from a high-quality land bank with a number of attractive redevelopment opportunities. In addition, their shares are out of favour.

    Elsewhere, we are optimistic that our focus on quality growth companies with leading positions in their respective areas will afford them pricing power and enable them to perform well in a reflation environment. In terms of new ideas, a recent area of focus has been consumer staples – given that demand for low ticket, everyday items tends to prove more resilient when prices rise. We have already identified a few businesses that have piqued our interest and we plan to do some further work in this area.

  8. Conclusion

    In our view, the investment environment in Japan is undergoing significant change and we are orientating our research agenda and adjusting positioning to reflect this. However, our focus on businesses which can deliver superior growth will remain the same. Similarly, expect continued low turnover in the portfolio, in keeping with our long-term approach and reflecting confidence that most of our holdings can deliver strong earnings growth, regardless of the macro backdrop.
  9. Risk Factors

    The views expressed in this article are those of Baillie Gifford and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

    This communication was produced and approved in fourth quarter of 2017 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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