Tokyo finds favour despite Beijing stand-off

Chinese broadcast media, echoing pronouncements from the Beijing authorities, have recently focused on one key geopolitical development — a hostile stand-off with neighbouring Japan.

Following high profile comments of newly elected Japanese prime minister Sanae Takaichi — describing any potential Chinese attack on Taiwan as an “existential threat” to Japan, even requiring military response — Beijing announced economic sanctions.

Officials talked about making the Japanese economy suffer substantially, as Beijing blocked imports of much-prized Japanese seafood and scrapped joint events between the two Asian nations. Many Chinese tourists immediately sought to toe their government’s line, axing travel and tourism plans to Japan in response.

“When there was Russia’s full-scale invasion of Ukraine of February 2022, there was an initial shock and then remarkably, markets adapted to there being a large-scale conflict in Europe,” says Louise Tumchewics, an expert on conflict studies and visiting fellow at the University of Southern Denmark during filming of a forthcoming early December episode of PWM’s Tea Break. 

“With China and Japan, however, I could see this being much more consequential for the global economy…given just how crucial Taiwan and the Taiwan Strait area are for China, Japan, Taiwan and the rest of the world.”

Managing risks

Given the unpredictability of geopolitics, and “the future trajectory of ongoing events” in Asia, Cheuk Wan Fan, Hong Kong-based chief investment officer for Asia at HSBC Private Bank stresses the importance for private clients of managing risks and positions within their investment strategy, despite the generally positive backdrop.

Japanese exporters will continue to benefit from a weakening yen. Moreover, she emphasises the Japanese government’s policy roll-out in response to geopolitical uncertainty. The “massive fiscal stimulus” she says, equivalent to more than 3 per cent of Japanese GDP, “will directly support economic growth”. Consumers will also be given fiscal incentives to spend, now that Japan has exited its deflationary stage and prices have once more began to rise.

For HSBC, this means focusing on Japanese consumption plays, and backing financial institutions, which have been delivering solid performance, while avoiding bilateral tourism and trade stories.

“In terms of risk management, we will avoid those sectors which may be impacted by a deteriorated trade relationship between China and Japan,” says Ms Fan.

Like HSBC, many investors remain positive about Japanese equities, despite current tensions with China.

‘Cautiously constructive’

“Japan’s equity outlook remains cautiously constructive despite evolving geopolitical and economic dynamics under the new prime minister,” says Dan Hurley, portfolio specialist in the international equity division at US investment house T. Rowe Price.

“While recent political shifts have introduced uncertainty, history suggests Japan and China are likely to remain pragmatic in navigating their periodic trade tensions,” says Mr Hurley, citing Japan’s release of the Fukushima treated water in 2023, boat collisions and the rare earths dispute as examples. “These were contentious at the time but didn’t really have a major impact on trade, perhaps only having a small impact on tourism and consumer exports.”

Intertwined economies

The two economies, he says, are deeply intertwined, with both sides recognising the importance of maintaining stable commercial ties, given the scale of bilateral trade.

As well as the new prime minister’s pro-growth policies, including continued structural reforms, productivity enhancement and corporate governance improvements, Mr Hurley highlights the renaissance of Japan’s semiconductor system as an “incremental tailwind” which may help maintain the country’s investment case.

“TSMC’s expanding production presence, where progress has been smoother than its efforts in Arizona, reinforces Japan’s strategic role in the global chip supply chain, even if current output is not yet at the leading edge,” he adds.

Sentiment is even more positive at rival US funds firm Neuberger Berman, where equity analysts believe investment from overseas chip giants will greatly improve the sustainability of Japan’s growth over the mid- to long-term.

The Japanese government is taking a holistic approach to wooing such companies, says Neuberger’s head of Japanese equities, Keita Kubota. “In the case of TSMC, the Japanese government not only provided tax breaks and subsidies to the Taiwanese chipmaker, but also facilitated relationship building with local universities to set up training centres and programmes to educate and train future engineers.”  

The semiconductor sphere is also seen as one of the key focus industries under Ms Takaichi’s economic policy. The Japanese economy continues its “paradigm shift”, inching closer to the end of “lost decades” of deflation, he says, now that wages are continuing to increase, while companies pursue corporate governance and capital management reforms for shareholder value creation.

The investment case for Japan will be further strengthened by the PM’s targeted fiscal expansion policies, by “bringing the growth story back to the driver’s seat of the economy”, says Mr Kubota.

Calm reactions

“Many of our investment companies with exposure to China have reacted with calm as this is not the first time relations between the two nations have soured over political issues,” he says.

Neuberger’s equity strategists believe China will remain a key market for Japan and Japanese companies “with strong fundamentals backed by pricing power.” These companies, says Mr Kubota, should be able “to continue seeing sustainable growth in any market including China over the long-term, and these are the types of companies we like to invest in”.