Japan has recently elected a new Prime Minister, Shinzo Abe.    He comes in on a platform of reflation.  Japan has battled a deflationary slump of 23 years now.   However, things appear to have begun to change.  They yen has declined, and the stock market has perked up, having risen sharply since the middle of November. 

Japan has had a litany of problems in the last 20 years.  The stock market peaked in 1989, at an Index level of more than 39,000 on the Nikkei -225.  Recently it is hovering around 11,000 after rallying by 33% since mid- November.   Japanese equities are by most measures quite cheap.  However, that does not make investing there terribly interesting.    The demographics are bad, the politics have been bad, and one by one the iconic Japanese brands seem to be falling by the wayside. 

Despite some recent positives, Japan has one big problem that is hard to get around, though it is not often mentioned.  Collectively capital is not treated very well there.   One way to see this would be to look at the return on equity for the Japanese market versus the US.  Doing so, one can see that returns on capital are much lower than in the states.   In Japan the Nikkei 225 Index has occasionally posted returns on equity above 10% in the last dozen years, but never by much.  In the US the S&P 500 Index over the same period, has occasionally posted returns on equity below 20%, but not by much.     

This suggests that there are assets on the books in corporate Japan that probably shouldn’t be there.   Business lines which should have been spun out, sold, or shut down tend to linger on the books.   M&A and private equity are nearly non-existent in Japan, though it has been tried.    This tendency to hold on to things even when they fail is a big enduring problem. 

Japan is now embarking on more aggressive policies to stir economic growth, which is a good thing, and long overdue.   This may have some positive effect on returns, but Japan needs more than that.  They need a good dose of capitalism.  Capitalism is all about earning returns on capital.  Japan struggles with this. Until their economy comes to grip with it, Japan in the aggregate is just a trade, maybe a good one though. 

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