When the going gets tough, the tough get perspective (Japan)

Key takeaways:

• For the US administration, tariffs are ideological; the US is taking steps to redefine global terms of trade
• As a policy step that can be reversed at any time, this makes portfolio construction problematic – we are mostly sitting on our hands, waiting for a clearer sense of asymmetry before being more active.
• Investors need to stay focused on their “North Stars” – we are maintaining discipline around constructing a portfolio of intentional, non-correlated company-specific investment opportunities.
• We believe the enduring investment case for Japan lies in the changing behaviour of corporate Japan, where returns are underpinned by self-help and capital discipline.

Welcome to the new world order

Historians have argued in recent years that the US has been returning to its pre-World War II role in global markets. In fact, in his “Liberation Day” speech on 2 April, US President Donald Trump even cited his country’s historical tariff use from the 1700s to the early 1900s, claiming that the Great Depression might not have happened if the policy hadn’t been abandoned. We’ll let the historians argue that one out.

The Liberation Day tariff announcements sent global markets into turmoil as Trump introduced baseline tariffs of 10% on all imports followed by additional “reciprocal” tariffs on 60 countries he dubbed the “worst offenders”. These included China, Japan and India. Financial market stress became so acute that the White House was forced to pause these for 90 days, opening the door to negotiation with a notable exception, of course: China.

“As far as financial markets are concerned, this is an iceberg moment.”

As far as financial markets are concerned, this is an iceberg moment. Unusually, it’s not an economic iceberg but an ideological one. Being self-imposed, it can be walked back at any time making it entirely different from the type of shocks that underlie most living investment muscle-memory reactions.

Attempt to reset global trade

Markets seemingly underestimated the ideological resolve of the new US administration. It appears that tariffs are not just about getting a better trade deal; the White House tariff rhetoric is increasingly sounding like the trade ideology espoused by Sir James Goldsmith some 30 years ago¹.

The argument is that global free trade – as practised – has become a race to the bottom with goods produced in countries where labour is cheapest, regulation weakest, and human dignity most negotiable, then shipped back to nations who have forfeited their productive capacity and undermined their social cohesion.

The argument further holds that trade policy should not solely be about maximising efficiency or profits, but about ensuring economic activity serves the broader interests of society. It seems that the White House is attempting a reset to the world that unfolded with The General Agreement on Tariffs and Trade (GATT), established in 1948, and its successor the World Trade Organization (WTO), which was founded in 1995.

We think it’s fair to say that this is a bigger deal that most were expecting. Whether we accept the straw man presented above, whether we agree with it or not, whether we think that the White House might be fighting a battle that moved on 40 years ago, the US is now, in fact, taking steps to redefine global terms of trade. There can be little debate that the magnitude and the speed of the changes being sought are almost as shocking as the bluntness of the tools being deployed.

This feels very much like a US Brexit moment; whether one is in favour or against reforming our global free-trade model, it seems unlikely that abrupt, blunt, volatile, unilateral measures mired in antagonistic narrative will smoothly deliver the White House’s desired results.

On the other hand, reckless policy behaviour does carry a significant probability of unleashing wild, unintended consequences in the global economy.

Systemic uncertainty

Understandably, markets are rattled and companies are already hitting the brakes. On 9 April, financial markets were perilously close to a major, widespread malfunction before the “90-day pause” was announced. Unleashing this level of systemic uncertainty is needless and irresponsible, in our view. In the best-case scenario, it imposes a tax on growth and with that comes, almost certainly, recession-type outcomes.

“Investors will need clarity, one way or another, on the global trade and tariff debate, before they can move forward”

However, this is not just a growth scare; it’s a question mark over the nature of the regime we operate in. Investors will need clarity, one way or another, on the global trade and tariff debate, before they can move forward, sustainably, in a pro-risk manner.

As mentioned above, one thing that is distinct about this economic and financial market episode is that it is manufactured. This is not an economic iceberg that causes instant damage. This is a policy step that can be reversed at any time. This makes portfolio construction problematic.

If the White House misjudges, markets could easily spin out of control. On the other hand, if it pulls back, significant price relief will likely ensue. For once, amidst turmoil, we are, for now, mostly sitting on our hands and a low tracking error, waiting for a clearer sense of asymmetry before being more active.

Maintaining discipline

In times like this, when exceptional volatility and regime-level uncertainty wreak havoc, we believe it’s important for investors to stay focused on their “North Stars” – whatever they may be.

For M&G’s Asia Pacific Equities team, that means maintaining discipline around our goal of outperforming our benchmarks through the construction of a portfolio where active risk is deliberately dominated by intentional, non-correlated, differentiated, asymmetric, company-specific investment opportunities.

We source these stock picks from a curated universe of companies we have developed over 20 years and match that with a pragmatic approach to portfolio construction that emphasises the avoidance of undue macro, sector or style risks.

Inevitably, the “God of markets” does not deliver a steady stream of single-stock alpha opportunities each month; alpha appears in a lumpy fashion. Sometimes we see and exploit the alpha, sometimes we miss it, but we are always vigilant and disciplined about what we definitely don’t know. 

“Market sell-offs can be amazing opportunities to add or destroy value.”

Market sell-offs can be amazing opportunities to add or destroy value, depending on the circumstances at play and the investor’s reaction function. For us, this was an unusual sell-off, as described above.

With correlations so high and with, so far, little obvious asymmetry being built into markets, it’s not obvious that we should keep our active risk anything other than modest. “Fatter pitches”, or more attractive opportunities, will come.

Whilst we exercise “aggressive patience”, we go back to our research, back to scenarios and simulations, to evidenced-based observation. We lean on our learned sense of the risk of ownership for our coverage companies and wait for opportunities where the odds are stacked in the favour of ownership, in the context of a portfolio sculpted to isolate other sources of return noise.

As we often admit, we will not forecast the future better than the market or our competitors. However, we do expect to identify, quantify and price the risk of ownership in a superior and consistent manner. In time, that superior perspective helps us to identify when to be aggressive and when to be patient.

Japan: positive trends in micro environment

Prior to Liberation Day, Japanese equities were already suffering from “global macro-itis”. A resurgent dollar, sticky global inflation, and hawkish signals from the Federal Reserve kept risk assets in check worldwide in the year leading up to the end of Q1 2025 and Japan was no exception.

As we contemplate Q2 and beyond, the situation has of course been completely overtaken by US tariff activity. This is now the single most critical topic facing global markets and the closest thing we’ve seen to an existential threat since the global financial crisis. For us, the issue is not so much what the direct impact of tariffs is, but what effect the collapse of economic trust and erosion of global economic governance might have.

“From a relative perspective, we think Japanese equities are once again very attractively valued for mid-term investors.”

From a relative perspective, we think Japanese equities are once again very attractively valued for mid-term investors. Japanese corporates remain well capitalised (under-levered) with a better-than-ever inclination to exploit low-hanging fruit on the self-help and productivity front.

This opportunity is well spread across a stock market that has breadth. This is distinct from the US situation where the market is heavily concentrated by ultra-large market cap companies that have been among the world’s biggest beneficiaries of the very global trade model that the White House seemingly wants to dismantle.

A new equilibrium

Closer to home, the Bank of Japan’s exit from negative interest rates – while modest and well-telegraphed – has reignited debate about the implications for asset valuations, funding costs, and currency dynamics.

But these are tactical headwinds, not structural flaws. Real interest rates are still deeply negative and inflation, while elevated by Japan’s standards, is largely being driven by benign forces: wage growth, mild pricing power, and ongoing economic normalisation. This is not a country fighting to escape deflation anymore. It is a country learning how to manage a new equilibrium.

Although the perception exists that Japan is an export-sensitive economy, in reality Japan’s ratio of gross exports to GDP is relatively low in an OECD context. Japanese exports to the US are roughly 3.5% of GDP, in fact².

While we suspect many Japanese companies will demonstrate pain in the upcoming “guidance” season to appease the White House, the underlying reality is one of relative resilience. Japan dealt with tariffs in decades gone by and responded with local production wherever practical.

“Growing concerns about global growth and geopolitics have undermined Japanese equities in the last year, we feel.”

And on the topic of perceptions, investors have long since viewed Japan as a levered play on global growth. While we are less convinced this remains the case today, that investor muscle-memory is real. As such, growing concerns over global growth and geopolitics have undermined Japanese equities in the last year, we feel.

Forward earnings-per-share estimates as of the end of Q1 are approximately 11% higher than a year prior³, but the market is broadly flat in local currency terms over the past 12 months. Implicitly, investors have already been modestly nervous about the earnings estimates/outlook. This feels fairly rational given political uncertainties, the tariff issue and the potential for yen strength. One could argue that some of the potential downside has already been priced in.

Changing corporate behaviour

We believe the enduring investment case for Japan lies not in monetary policy or global flows, but in something quieter: the changing behaviour of corporate Japan. The foundational forces that powered the 2023 rally remain intact, in our view, and are, in some respects, strengthening. M&A, buybacks and dividends are all tracking towards yet another record year.

At the corporate level, animal spirits are growing. We believe Japan’s micro environment, then, continues to offer a compelling case for durable, compound returns underpinned by self-help and capital discipline – attributes that rarely go out of fashion.

¹Sir James Goldsmith was a 20th century French-British businessman, politician and environmentalist, now for his critical views on global trade and globalisation.

²OEC World (website), accessed April 2025. Figures refer to 2023.

³Bloomberg, 9 April 2025. Bloomberg consensus estimates.