So much has happened in the last week or so that October seems like a distant memory. I suspect most people have little care of what happened prior to Nov 5 and are much concerned (as are we) of what will happen from here. But just to focus on October for now, unlike the US, large caps massively outperformed small caps with the Topix 100 rising +2.8% while the rest of the market was essentially flat (within MSCI’s universe, MSCI Japan Large was up +3.3% while MSCI Japan Mid was down -0.5% and Small +0.4%). As such, the strength was concentrated in a small subset of names. The exporter-heavy Nikkei 225 was up +3.1% due to huge move in currencies with the carry trade back in full force and the yen weakening from 142.60 to 152.46. The yen essentially reverted back to levels in the summer before the surprise BOJ rate hike, although this massive movement probably had less to do with the Trump trade as the yen started to weaken well before XBT or DJT started to trade upward. Despite the yen, the sectors that outperformed were Financials, Pharma, Utilities, and Commodities not your typical FX-sensitive names (although Precision and Autos outperformed slightly as well).
 
We had also entered earnings season, and the trend was, to say the least, complicated. I noted both after Mar Q and Jun Q results that post-earnings stock action is becoming less straight-forward than in the past where implied fundamentals do not necessarily equate to market expectations nor stock reaction (which, itself, varies significantly by coverage, market cap, and sector). Slight beats/misses vs the whisper number appear to cause large swings in the stock.
 
But, so far, there were some clear notable trends. First, autos, machinery, and industrials overeall were mostly weak. Despite the weaker yen, we saw many second half downgrades due, not in small part, to the optimistic guidance announced after fiscal year end, most of which were expecting a bottoming during the first half (Apr~Sep 2024) with a strong recovery in the second half (Oct~Mar 2025). This, not surprisingly, did not materialize due to the weak order bookings during the spring and summer. The revisions were very sharp with many guiding for flat half-on-half revenues/profits which is highly below seasonal. Secondly, there was a clear bifurcation within tech, notably between equipment, chemicals, and components. Equipment remained very strong while chemicals were firm only for those supplying to leading edge nodes while components were weak. In other words, unless you have high exposure to “AI” or data centers, set demand is weak and channel inventories are still high. Thirdly, there has been yet another notable jump in payouts whether it be buybacks or dividends. We’ve seen several cases where the cross-shareholding unwind by financials or group companies were being absorbed by the target through buybacks. Furthermore, despite the many downward revisions, dividends are being maintained and, in cases of upward revisions, are often being hiked. While still terribly rudimentary, the ROE initiative by the JPX seems to be taking hold. Finally, it feels like there is more deal activity whether it be friendly or hostile. Using a quick lookup using Bloomberg (hardly the best source but the only one readily available to me), the number of completed or pending deals whose target is a publicly traded Japanese company numbered 183 as of October end. Historically, November + December deal announcements average over 50 making the estimated total 233, the highest number since 2010. I have a feeling that this is set to rise next year and beyond. I recently spoke at the 1st annual Asset Management Forum (part of the policy plan by the Japanese government to promote Japan as a leading asset management center) and I heard several global private equity firms pitching their Japan story. Given the difficult environment outside of Japan and the higher funding requirements, I could practically hear them salivating on the opportunities growing in Japan (although I would note that valuations continue to be much cheaper in the public markets and acquisitions are not driven by financial reasons alone, making the typical Western private playbook less straightforward).
 
Anyway, back to our portfolio, none of our names had announced during October (although three had on Oct 31 after the close; two out of the three are outperforming the benchmark month-to-date so far) so our October performance was led more by the flows and illiquidity of the smaller cap names in both directions; outside of the last 2 days when earnings began in full force, October volumes were largely quiet given the many uncertainties as we looked toward November. While earnings are looking OK so far for our remaining names in the Fund, the bigger question is, what do we do from here. But I’ll get to that in part 2. ​

Masaki Gotoh​​

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“So, this is how Liberty dies … with thunderous applause.” – Padme Amidala, played by Natalie Portman, from Star Wars Episode III.

 

Of course, I’m being overly melodramatic. Liberty has not died (yet). And well over 50% of Americans would probably argue that Liberty had been restored, so who am I to say.
 
Japan’s Liberal Democratic Party who had governed Japan almost continuously since 1955 suffered one of its worst defeats in 15 years on Oct 27 (I, too, voted for an opposition party). Right or wrong, and despite the revolving door of prime ministers, we’ve had a fairly stable government until now, and I don’t think it will be an easy transition back. Much like many other countries in the world, the frustrations of the working class came to a boil although not entirely due to a rise in right-wing populism; arguably, Japan was already a little populist to begin with, but more to the center, if there is such a thing anymore. But if it’s happening in Japan, in my opinion being one of the most tolerating cultures in the world, the world really must be on edge.
 
Conversely, the people of the United States, who hadn’t had a unified government for a stretch of more than 4 years since George W. Bush (and before that since, surprisingly, Jimmy Carter), voiced similar frustrations from the working class. And, like so many other countries particularly in Europe, they had embraced populist nationalism. So, unlike the stable Japanese government that had splintered, the US is now unified for at least the next 2 years and, looking at the disarray within the Democratic Party, possibly much, much longer. It is amazing that one person could make such a difference, just like another famous president, John F. Kennedy, had said … (as did the Knight Rider for all of the 80s TV fans). But I doubt either meant that it could happen so suddenly.
 
Now, I realize that the financial markets were already leading up to this outcome around mid-October as were the betting odds, so it should come as no surprise. Still, many of my (Japanese) friends around me were surprised by the results of Nov 5th. But what was equally surprising was the Japanese equity market reaction as the polling results came through during market hours throughout our Nov 6th. Now I can understand why other markets would react the way it did whether it be currencies, bonds, commodities, or crypto. And other Asian markets such as Korea and China fell intraday which made sense. But, for some reason, Japan drove upward with each new swing state turning red. At the time, I just assumed it was a reaction to the weakening currency throughout the day (despite the fact that the Korean Won was also weakening but their equity markets were falling). Or maybe it’s because Japan is, relative to other countries who are US partners, somewhat closer to the US economically and politically apart from Canada who I’m sure is much closer (Mexico and China are also comparable trade partners to Canada but they have other issues with the US, especially with a Trump presidency, as we can all surmise). While I seriously doubt that our newly appointed prime minister Ishiba-san could be as diplomatically suave as Abe-san, if at all, he certainly won’t be combative, especially given his minority coalition government that is hanging by a thread. In either case, I did find it odd because, outside of a weaker yen (for longer), I couldn’t quite understand what the immediate benefits were. Our largest trade partner is still China which feels like an increasing risk. While are ties with the US are strong, our trade imbalance is 5th after China, Mexico, Vietnam, and Germany. Our competitive position may fall as US lowers taxes (while our economics-challenged PM wants to raise taxes). A tit-for-tat trade war won’t be good for anyone, nor would excessively high US inflation and interest rates.
 
Admittedly, a strong US economy is incredibly beneficial for Japan. If the insatiable demand for credit by the US consumer can outweigh rising inflation and they continue to drive global demand as they have in the past, we’ll be OK even with a few tariffs here or there. Besides, I’m guessing (hoping) that tariff negotiations can be overcome via higher imports; I’d be happy to switch my daily breakfast routine from rice to bread and we could always use plenty of shale gas.
 
But, ultimately, what can we truly know what will happen during the next 4 years? I mentioned in previous monthlies that Japan has its own unique circumstances starting with the implosion of the real estate bubble in the late 80s that has finally culminated into a new era for Japan (with both its positive and negative potential outcomes). The world also seems to have transformed significantly compared to pre-COVID. And now, another major new element has been brought into the mix, one whose consequences are less clear.
 
We, like I’m sure every other asset manager in the world, have been going through possible economic reactions to the Trump/Harris scenarios for the past several months, but, until Nov 5, it was still theoretical. Now, while the consequences are still hypothetical, we at least have an answer to that very binary question. And on Nov 6, we too debated how we should think about our portfolio, first the risks, and second the opportunities. Also, we have to bear in mind that practically every news outlet, economist, and strategist were pointing to similar outcomes. So, as an equity analyst, we must also consider the possibility that they are wrong; when everyone says the same thing, I turn cautious.
 
I should like to stress again that the concentration and selection of businesses in our portfolio were chosen for idiosyncratic reasons. Having said that, we are always aware of factor exposures and, when we research potential new additions, we seriously consider how the portfolio exposures might change upon addition/replacement of new companies. So, with that caveat in mind, we had focused our existing portfolio with relatively high domestic exposure (given our views of the long-term trends of the Japanese economy), though we do have some health care (in a broad sense) and a smidge of auto and SPE. Because of this, we had prioritized research of global names that, when the timing is right, we could add to rebalance our portfolio. As such, we already had very little exposure to China. What few exporting manufacturers we do own, they produce in the US or their competitors are mostly non-US companies who would be subject to similar tariffs. One thing we do lack is weakening yen exposure and, if anything, had been preparing for a strengthening of the yen. As we research new companies, the risk of a strengthening yen can probably be lowered which lowers the bar to add exporters in the future, a clear change from our views during the summer, particularly after the BOJ rate hike. Still, given the downward revisions for the Oct~Mar 2025 half by many exporters, I suspect we have plenty of time to do our research which may also give us time to increase visibility of the possible impact from the Trump presidency.
 
But I still prefer to focus on what is (more) certain and that continues to be our views on the transforming Japanese economy. The best investment would be one that can take advantage of both, and some of the companies that we already had begun researching from the summer looks that they may. And should the world tip into recession because of higher US inflation, our Quality mantra protects us in the long-term as they tend to fall less as the economy weakens and recover faster when it reverts with higher market share than when going in the downcycle. And I believe that the potential changes to world trade would benefit our Quality businesses who are better positioned for these uncertain times. Despite all of the drama in the last 2 weeks and all of our hypothetical scenario analyses, not much has changed from an investment perspective. And that is comforting, I must say.
 
Japan was just starting to get interesting. But, I think now, it’ll be even more so with the new world order as the bifurcation of winners and losers within Japan widen.

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