Podcast Summary: "Why Japanese Stocks Could Outperform"

Podcast: Money For the Rest of Us
Host: J. David Stein
Guest Host: Greg Dowling (FEG Investment Advisors)
Guest: Howard Smith (Indus Capital)
Date: March 5, 2025

Episode Overview

This episode dives deep into the evolving opportunity in Japanese equities, challenging the long-held narrative of stagnation and disappointment. Howard Smith, a seasoned Japan-focused portfolio manager, argues that Japan is at a turning point, with catalysts like corporate governance reform, industrial expertise in critical technologies, and shifting international dynamics. The conversation, hosted by Greg Dowling (FEG), is rich with context—historical, economic, and cultural—framing why Japanese stocks could offer attractive returns for global investors in the coming decade.

Key Discussion Points & Insights

1. Japan’s Evolution: From Bubble to Renaissance

• Career Beginnings and Japan in the 1980s
  • Howard Smith explains how Japan’s bubble era (late 1980s) sparked his lifelong fascination.
  • Quote: “I graduated in 1988… that was pretty much the peak of Japan's asset bubble at that time. Everyone was telling me… we’ve got a lot to learn from them.” – Howard [06:15]
• Historically Long Slump, But Recent Progress
  • The Nikkei peak in 1989 wasn’t surpassed until 2024/2025.
  • Quote: “I think really triggered in me a lifelong love of Japan. My whole working career has been centered around Japan ever since.” – Howard [07:30]
  • Major changes began around 2012/2013 with the arrival of Prime Minister Shinzo Abe and his “three arrows” reforms: monetary easing, fiscal stimulus, and structural reform (notably, corporate governance enhancements).

2. Japanese Culture and Its Economic Impact

• Familiar Yet Different
  • Japan is an advanced, modern society but with a distinct cultural orientation: consensus-driven, adaptive, and always reinventing.
  • Quote: “A desire for harmony and consensus, a desire not to rock the boat so much. But behind that, there's a quiet determination and an ability to adapt and change.” – Howard [09:17]
  • Recent optimism: “Japan is coming out of a long era of very low economic growth… I think over the next 10 years we’re all going to be rather surprised by Japan.” – Howard [10:06]

3. Modern Japanese Economy: Industries and Brands

• Beyond Toyota: Global Industrial and Consumer Power
  • Advanced manufacturing (20% of GDP vs. 10-11% in US): automotive, semiconductors, robotics, material science.
  • Japan produces critical components in semiconductor value chains—essential for global AI and tech growth.
  • Soft power in global consumer brands (Nintendo, Uniqlo, high-end watches).
  • Quote: “No Nvidia chip is going to be made without a lot of input from Japanese companies somewhere in that value chain.” – Howard [13:33]

4. Abenomics and Corporate Governance Revolution

• The “Three Arrows” and Their Delayed Impact
  • Abe’s monetary and fiscal easing reflated the economy, raising inflation and nominal GDP.
  • Third arrow (structural reform): new governance codes, stewardship, unwinding cross-shareholdings, higher return targets, board independence.
  • Quote: “Corporate governance in Japan is remarkably different to how it was 10 years ago… the scorecard’s actually a lot better than people think.” – Howard [16:23]
  • International investors are skeptical and demand a ‘story’ from Japan, but Howard argues performance is now self-evident.

5. Valuation, Returns, and the Weak Yen

• Current Opportunities
  • Japanese stocks are cheap: MSCI Japan trades at 14x forward earnings vs US at 22x.
  • In yen terms, 10-year returns were 9% annualized, but only 6.2% in US dollar due to yen depreciation.
  • Quote: “The local currency asset price inflation has been strong… I think there's a lot more to play for, I think we're still early innings in this story.” – Howard [20:20]

6. Japan as a “Back Door” to Global Tech and Friend-shoring

• Key Role in AI & Semiconductors
  • No Japanese FANG equivalents, but dominance in equipment and materials for chips.
  • Major multinationals (TSMC, Micron) are now building in Japan, facilitated by friend-shoring and reshoring out of China.
  • Quote: “Japan is naturally very well placed to be a beneficiary of friend shoring or reshoring as the world disentangles itself from China.” – Howard [28:05]

7. Risks & Challenges

• The Yen Carry Trade
  • Recently (Aug 2024), fast unwinding of the yen carry trade (borrow in yen, invest elsewhere) caused global market ripples.
  • The interest rate differential (US vs Japan) drives this; future rate changes likely to support a stronger yen.
  • Quote: “I still find the yen profoundly undervalued at this exchange rate. It's still at a 50 year real effective low. Anyone getting off the plane in Japan will see… their sushi lunch is eight bucks there and it's 32 bucks in New York City.” – Howard [31:54]
• National Debt Concerns?
  • Japan's debt is mostly held domestically by the central bank, not a risk like in countries with external debt.
  • Biggest worry: terms of trade and reliance on imported energy/materials.
  • Quote: “I don't worry about the public debt at all. I worry more about the terms of trade. Japan being a big importer of energy…” – Howard [34:08]

8. Corporate Governance in Action: The 7-Eleven Case Study

• 7-Eleven’s Changing Ownership and Governance
  • Ongoing bid by Canadian Circle K owner (Couche-Tard) to acquire Japan’s Seven & i Holdings (owner of 7-Eleven; itself once a Texas company).
  • This potential cross-border deal tests Japan’s openness to foreign control and market discipline.
  • Quote: “Shareholder registers are much more open. Japanese management are being held much more accountable… Activist investors are much more present in the Japanese market now than they were historically.” – Howard [37:15]
• Convenience Stores as a Microcosm
  • 7-Eleven in Japan dwarfs its US equivalent in freshness, cleanliness, and essential daily life role.
  • “711 or convenience stores in general in Japan are deeply woven into the fabric of everyday life…” – Howard [38:45]

9. Private Equity & Activism

• Increased Foreign and Domestic M&A
  • More PE activity (KKR, Bain, Carlyle), more management buyouts, and higher boardroom activism.
  • Howard describes his own firm’s (Indus) role in constructive, operational activism, different from “quick in and out” Western styles.

10. Advice for the Curious: Books and Resources

• Recommended Reading
  • The Business Reinvention of Japan by Ulrike Schaede — deep dive into Japan’s adaptability and niches [45:30]
  • Abroad in Japan by Chris Broad — personal, humorous take on expat life in Japan and cultural quirks [46:40]
  • Chris Broad’s YouTube channel, “Abroad in Japan”, also recommended.

11. Cultural and Personal Touches

• Lightning Round (47:39)
  • Godzilla or Anime? — Howard: Godzilla (“I never really made the leap to anime.”)
  • Sushi or Yakitori? — Howard: Yakitori (“Cooked food over raw food probably most of the time.”)
  • Closing in Japanese: Howard thanks listeners in formal Japanese, noting the importance of cultural respect and fluency [48:45].

Memorable Quotes

• “Japan is coming out of a long era of very low economic growth and low inflation and kind of a loss of relevance in many respects. But I don't think that's a permanent state of affairs and I think over the next 10 years we're all going to be rather surprised by Japan.” – Howard Smith [10:06]

• “No Nvidia chip is going to be made without a lot of input from Japanese companies somewhere in that value chain.” – Howard Smith [13:33]

• “The more constructive, thoughtful operational activism is the kind of approach that’s going to ultimately generate higher returns, I think, in Japan. But you’ve got to stay the course sometimes…” – Howard Smith [44:10]

• “Japan is still so mispriced and so misunderstood.” – Howard Smith [45:09]

Timestamps for Key Segments

• [05:13] Introduction to Howard Smith and Indus Capital
• [06:10] Japan’s bubble era and Howard’s career start
• [08:34] Japanese cultural and economic differences
• [11:16] Modern Japanese industries, brands, and manufacturing strength
• [15:01] The “three arrows” of Abenomics and Japanese reform
• [20:20] Japan’s stock market performance, valuation, and skepticism
• [23:45] Japan as a key tech enabler and opportunity for investors
• [26:04] Friend-shoring/reshoring and Japan’s role in global supply chains
• [30:01] The yen carry trade explained and currency market events
• [33:15] Japan’s debt—Why Howard isn’t worried
• [36:45] The 7-Eleven/Couche-Tard case as governance litmus test
• [41:39] Private equity, activism, and market for corporate control
• [45:27] Book recommendations on Japanese business and culture
• [47:39] Lightning round: culture and food
• [48:45] Closing remarks in Japanese

Conclusion

This episode provides an in-depth, nuanced look at why Japanese stocks may be poised for outperformance: the transformation underway in Japanese corporate governance, critical roles in global industrial supply chains, improved macroeconomic conditions, and undervalued equities in a world starved for quality growth at reasonable prices. For investors willing to look past stale narratives and accept a longer holding period, Japan could offer substantial rewards in the years ahead. Howard Smith’s experience and optimism make for an illuminating, actionable listen.