https://www.nb.com/en/global/insights/japanese-small-caps-may-hop-in-the-year-of-the-rabbit

Did you know that Japanese small cap stocks outperformed US and European peers by a wide margin last year?

In the linked report by Neuberger Berman, Kei Okamura, Portfolio Manager, pointed out that Japanese small was down just 0.33%, while their U.S. and European peers dropped 7.98% and 18.01%, respectively.

Mr. Okamura cites the critical parameters which show these outperforming Japanese small caps are still trading discount to its peers in the developed economies.

Attractive valuation and low analyst coverage (Source: Japanese Small Caps May Hop In the Year of the Rabbit, by Kei Okamura with Neuberger Berman)

The above chart highlights that MSCI Japan Small Cap group is trading at a substantial discount at P/B of 1.05 at year-end of 2022 vs. MSCI US SC with 1.8x and MSCI Europe SC of 1.34x.

Institutional Analysts are less compelled to cover Japanese names, leading to the high possibility that many great small cap names have not been discovered nor property valued by global investors who don’t have resources nor inclination to search for undervalued Japanese names on their own.

Mr. Okumura goes on to list three macro forces to drive Japanese small caps steady performance in 2023. These are 1) post-covid reopening of Chinese economy, 2) relatively stronger domestic year-over-year demand increase in Japan vs. US and Europe and 3) broad corporate governance reform

I am not in a complete agreement with him on these reasons, since: 2) painfully snail pace increase of wages will make it difficult for consumers to loosen their wallets amidst rising inflation, and 3) corporate governance report appears to take longer to be realized than market participants have hoped.

However, I concur that China reopening will likely provide small caps in Japan with tail wind, many of which had suffered from “Zero Covid policy” which Chinese government had instituted for almost three years. In fact, selectively investing in Japanese small caps may be a cost effective way to benefit from expected Chinese consumer spending recovery in 2023. As Mr. Okumura has adeptly illustrated in the linked report, China is the largest trading partner of Japan. The tie may go stronger amidst heighten US-China political tension.

I highly recommend you take a read at Mr. Okumura’s well laid-out for your global portfolios.

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