Latest News on the Israeli-Palestinian Conflict (November 12)

For the best part of this tightening cycle, the Federal Reserve (Fed) has been playing a tug of war with financial markets, with the central bank trying to persuade investors that a period of higher interest rates is needed to bring inflation durably under control, and investors resisting or even “fighting” the Fed.

Over the past three months, the Fed seemed to have gradually prevailed, and bond yields rose to nearly 5%. The Fed, however, might have overestimated the extent to which financial markets had really come around to its view. At the November Federal Open Market Committee (FOMC) meeting, Fed Chairman Jerome Powell gave a gentle dovish nudge, not just with the expected decision to hold rates, but also in suggesting that growth might already be running under its (temporarily elevated) potential pace, and de-emphasizing the importance of the Fed “dots” (which point to one more hike). A handful of weaker-than-expected economic data compounded the impact on market prices.

So as Powell noted that the Fed's inflation fight was getting important help from tighter financial conditions, investors promptly drove financial conditions in the opposite direction, with lower bond yields and higher stock prices.

Powell said the Fed still needs to answer the question of whether monetary conditions are tight enough, and only after it has found the answer will it move to pondering for how long conditions should remain tight. However, investors quickly provided their own answers: Monetary policy is plenty tight already, and by the middle of next year it should start loosening at a brisk pace, to cut the fed funds rate to close to 4% by end-2024.

Satisfied with the progress achieved, Powell gave investors just a gentle nudge of encouragement, and they ran with it in a burst of what I see as an excess of exuberance.

The Fed is still grappling with three difficult questions:

How persistent is inflation?

How fast is the economy likely to lose steam?

Where does the neutral policy rate sit?

Compared to a year ago, inflation is now quite close to target—and yet still too far away. There are a variety of inflation measures that analysts throw around: consumer price index (CPI), personal consumption expenditures (PCE), headline, core, 12-month change, monthly change annualized. Some look very reassuring, others much less so.

My preference is to look at core CPI and take the month-on-month change, which gives us the current pace of price growth unaffected by older base effects. That rate, annualized, is still bouncing around a lot. In July it was just 1.9%; in September it was 3.9%. The three-month average is still above 3%; the six-month average is close to 4%. Other measures like headline CPI and supercore CPI – which strips out not just food and energy but also housing, and has been often highlighted by Powell – run even higher, with a three-month average close to 5%, as the chart below shows.

Inflation is not quite under control yet, and too volatile for comfort, especially with the risk of another energy shock always just around the corner. Plus, a number of structural factors, from demographics to the green transition, suggest that long-term inflation pressures will be more robust.

The US economy has proved extremely resilient, expanding at a nearly 5% annualized pace in the third quarter. As I have argued in previous “On My Minds”, this should not be too surprising; households had a healthy cushion of excess savings and fiscal policy remains very loose. Nonetheless, funding costs for households and corporates have risen across the board, and despite healthy balance sheets, monetary tightening is beginning to bite. The latest data are consistent with some deceleration in economic growth and job creation. Monetary policy just might be tight enough to cool the economy to the right sub-potential pace. Maybe.

As far as the neutral policy rate is concerned, I believe the Fed is too dovish; it still seems to think that once things have settled, short-term rates can again be quite low, though not as low as in the post-global-financial-crisis (GFC) period. My own view remains that the neutral policy rate will prove to be closer to 4% or higher rather than the 2.5% still envisaged by the Fed.

With all this, regarding the forthcoming monetary policy decisions, the Fed likely feels it is now in fine-tuning territory, justifying a prudent approach—watch the data, and decide meeting by meeting what to do next.

I would not rule out the need for another rate hike yet—inflation pressures remain resilient with plenty of scope for unwelcome surprises. And I strongly believe that policy rates will have to remain at-or close to current levels for the better part of 2024 in order to secure the sustained decline in inflation to the 2% target that the Fed is pursuing.

However, Powell's dovish nudge at the November press conference has sufficed to push markets in a completely different direction: They have not only priced out any further rate hikes, but now expect about a full percentage point of rate cuts next year, starting already before mid-year, which seems unreasonably aggressive, in my view. This in turn will now complicate the Fed's job and in my view, set the stage for more volatility and a likely rebound in yields over the coming months.

Important economic data and official speeches have a greater impact on the market and are our focus. Traders often use this information to interpret the market, look for clues, and discover trading opportunities.

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After taking a strong hit last Friday due to the disappointing US employment report, the dollar staged a shy recovery this week as several Fed officials noted that the stellar performance of the US economy keeps the door open to further rate increases. Just on Thursday, Fed Chair Powell said that they “are not confident” that interest rates are high enough to signal the end of their fight against inflation.

However, despite the recovery in the greenback, investors remained largely unconvinced that another hike may be on the table. According to Fed funds futures, they are assigning only a 20% probability for one last quarter-point increase by January, while pricing in around 80bps worth of rate cuts by the end of next year.

Maybe market participants expect inflation to pull back again, especially after the retreat in oil prices during October, and the economy to weaken going forward. Indeed, the Atlanta Fed GDPNow model estimates a 2.1% annualized growth rate for Q4, but in an environment of high interest rates and a stellar acceleration to 4.9% in Q3, this slowdown appears quite normal.

With all that in mind, next week, the spotlight is likely to turn to the US CPI data for October on Tuesday. The headline rate is expected to have pulled back to 3.3% y/y from 3.7% and the core one to have ticked down to 4.0% y/y from 4.1%. That said, considering that the PMIs for October suggested softer price pressures, the risks may be tilted to the downside, and with the y/y change in oil prices turning negative again, headline inflation could continue to soften going into year-end.

This could add credence to investors’ belief of no more rate hikes and several cuts for next year and perhaps hurt the dollar. However, as long as data relating to economic growth continues to suggest that the US economy is performing better than its major counterparts, any retreat in the greenback may just be a corrective phase. This could be confirmed if Wednesday’s retail sales and Thursday’s industrial production for October continue to point to a resilient US economy.

The UK also releases inflation data next week, on Wednesday. The headline CPI rate is anticipated to have slumped to 4.9% y/y from 6.7%, and the core one to have slid to 5.6% y/y from 6.1%. Nonetheless, according to the PMIs, prices charged by companies accelerated to a three-month high in October. Thus, in contrast to the US CPI data, there may be upside risks surrounding the UK numbers. Tuesday’s employment report for September could also be important as the average weekly earnings print may provide a glimpse of where inflation may be headed in upcoming months.

Last week, the BoE kept rates steady but noted that they remain willing to further raise them if there is evidence of more persistent inflationary pressures. Yet, investors see only a 15% probability of another hike. Ergo, data pointing to stickier-than-previously-expected inflation could boost that number, but even if they don’t, they may prompt investors to scale back some basis points worth of rate cuts anticipated for next year; not because of a brighter economic outlook but on fears that cutting massively to support the economy may result in inflation getting out of control, which could in turn lead to deeper economic wounds down the road. This, combined with cooler US inflation, could help Cable return above the key barrier of 1.2310 and perhaps emerge above its 200-day moving average. The nation’s retail sales for October are also coming out on Friday.

The aussie has been under pressure this week following the RBA’s dovish hike, as well as data and developments adding to concerns about China’s economic outlook. The probability of another hike at the December gathering is a coin toss, and thus traders may seek clarity in Australia’s employment numbers for October on Thursday. With the unemployment rate resting at historically low levels, labor conditions remain tight. The September data pointed to some cooling, but should next week’s numbers point to strength, the probability of a December hike may increase and the aussie could rebound.

However, any recovery could stay limited and short-lived if the Chinese numbers released the previous day add to the woes surrounding the world’s second largest economy. On Wednesday, investors will digest China’s industrial production, retail sales and fixed asset investment, all for October.

Japan’s preliminary GDP for Q3 is due to be released the same day. According to a Reuters poll, the Japanese economy likely shrank during the quarter, marking the first contraction in four quarters. Many analysts believe that the BoJ will phase out its ultra-loose policy next year, but a negative GDP figure could prove a challenge for the Bank’s plans and perhaps prompt traders to push the yen lower.

On November 9, the Chinese Ministry of Foreign Affairs issued a notice bluntly stating that the security situation in northern Myanmar is complex and severe, reminding Chinese citizens not to travel to northern Myanmar for the time being, and calling on Chinese citizens to move to a safe zone or return home as soon as possible while ensuring safety.

This is also the comprehensive and public evacuation warning issued by the Chinese Ministry of Foreign Affairs since the outbreak of the current conflict in northern Myanmar. Before this, the Chinese Embassy in Myanmar mainly issued messages reminding Chinese citizens to pay attention to safety.

When we review China's recent statements on the situation in northern Myanmar, we can clearly see that China's rhetoric has changed significantly and its attitude has become increasingly tough.

When Chinese State Councilor and Minister of Public Security Wang Xiaohong visited Myanmar on October 31 last month, the Myanmar military junta had already lost Qingshuihe Town, an important town on the China-Myanmar border. However, during the meeting, China mainly discussed cooperation in combating e-mail. Risks such as fraudulent online gambling remind the Myanmar government to protect the safety of Chinese citizens in Myanmar.

When Chinese Assistant Foreign Minister Nong Rong visited Myanmar on November 3, China directly asked Myanmar to cooperate with China to maintain stability on the China-Myanmar border. In other words, China has actually taken steps to maintain border security.

China has indeed stepped up patrols on the China-Myanmar border in recent times, but the impact on border residents cannot be ignored.

In addition, Agence France-Presse claimed in its report that one Chinese casualty had occurred in this round of conflicts. At the regular press conference of the Ministry of Foreign Affairs on November 7, spokesperson Wang Wenbin had already used harsh words. He said that China is highly concerned about the escalation of the conflict in northern Myanmar, expressed strong dissatisfaction with the casualties on the Chinese side caused by the conflict, and has raised the issue with relevant parties. We solemnly protest and China has also taken necessary measures to safeguard the safety of citizens’ lives and property.

Since then, China has begun issuing public evacuation warnings. There are various signs that the situation in northern Myanmar is indeed not optimistic. At least from the perspective of a third party, the Myanmar military government is somewhat unable to control the situation.

In fact, the Myanmar military government itself is aware of this. According to the "Lianhe Zaobao" report, at the Myanmar National Defense and Security Council meeting on November 9, Myanmar National Governing Council Chairman Min Aung Hlaing publicly warned that it is now important for the country At this moment, all people should support the government forces. If the situation is not handled properly, Myanmar may fall apart.

Generally speaking, for the Myanmar military government, the situation has now reached a critical juncture. If the Myanmar military government still cannot calm the situation, then this regime, which itself is not widely recognized by the international community, will only be more questioned. The end result is either that the country is torn apart, or that the military government is forced to step down.

Along with the change of seasons in the northern hemisphere, global financial markets have decidedly cooled in recent months. We believe this reflects a widening range of economic outcomes as a much hoped-for soft landing becomes less of a sure thing. While it may appear that a resilient economy and steady corporate performance belie our growing sense of caution, we see a common thread among key indicators that reveals an environment that is potentially more fragile than many market participants realize.

As evidenced by blow-out third-quarter U.S. gross domestic product (GDP) data, the U.S. consumer continues to power the domestic economy. Consumption accounted for 2.69 percentage points of the aggregate 4.9% annualized quarterly growth rate. We don't know how much longer this pace can last. The bulge in personal savings owed to pandemic-era stimulus packages has largely run its course. Furthermore, consumption has more recently been powered by credit cards. With borrowing costs having reset to decade-plus highs, we question American households' desire – or ability – to keep racking up such purchases.

Our reason for doubting consumption's durability is our long-held view that policy rates will remain elevated for longer – an assessment that is now largely accepted by the market. Compounding this risk is our belief that the U.S. economy – and others, for that matter – have yet to feel the full brunt of previous rate hikes. Relative to other tightening cycles, we are still in fairly early innings, meaning the curtailment of demand that is the intention of hawkish policy is still working its way through the system. Already business investment has slowed, with non-residential fixed investment contributing nothing to third-quarter GDP growth.

Perhaps the most powerful signal that economic growth faces headwinds is the meteoric rise in real yields, with that of the 10-year Treasury at roughly 2.50%. This represents the highest cost of capital in inflation-adjusted terms in 15 years. Importantly, nominal yields have continued to climb even as inflation has subsided. We interpret this as the recognition of a potential regime change in rates. Consequently, corporate managers will likely become more selective when allocating capital, as returns on investments must meet a higher threshold.

With both equities and bonds well beneath their mid-year highs, some investors may presume current prices adequately reflect the myriad risks posed by elevated rates. But we believe it's too early to sound the “all clear.” Within fixed income, mid- to longer-date Treasuries and mortgage-backed securities (MBS) have borne the brunt of the sell-off. Given our view that rates are likely nearing their peak in the U.S., these segments could merit consideration for investors seeking attractive yields.

This view, however, does not carry over to high-yield corporates, as the spread between their yields and those of their risk-free benchmarks remains below long-term averages. Our concerns for this segment are compounded by the risk of a harder-than-expected landing, which could stress some of these companies' leveraged business models.

Similarly, we don't see risks dispersed evenly across the equities landscape. Over the course of 2023, mega-cap technology and Internet names have held up better than the broader market, and their valuations remain above their long-term averages. Yet unlike still-frothy high-yield credit, many of these business models, in our view, are well positioned to weather an economic downturn given their consistent cash flow generation, strong balance sheets, and exposure to durable secular themes. Value and more cyclically exposed names, on the other hand, could come under additional pressure in a slowing economy.

Despite gathering headwinds, earnings estimates for U.S. stocks have held up well during the sell-off, while estimates for ex-U.S. equities have proven softer. The resilience of tech's business models has likely played a role in U.S. estimates holding firm, but we are less confident in other sectors should the country's consumption engine lose steam.

Lastly, a widening range of economic outcomes lends itself to increased market volatility. Uncertainty about the duration of elevated rates and rising geopolitical risks further clouds the situation.

When this type of volatility and uncertainty causes asset classes to move in tandem – as they have occasionally done of late – investors can lose sight of the need for diversification. After years of it not being the case, bonds once again have the potential to act as ballast to riskier assets in a broad portfolio. Yields have risen to levels that offer both attractive income potential and possibly lower levels of volatility if rates stay within their current range. And should a rapidly weakening economy force central banks to pivot – not our base case – bonds' potential for capital appreciation could offset losses in more cyclically exposed asset classes.

For three decades, Japan's economy stayed stagnant, plagued by a combination of low growth, low inflation, and low interest rates. The term “Japanification” became shorthand for the country's prolonged economic plight and a warning to other advanced economies hoping to avoid the same fate. However, Japan's economy is experiencing a revival in 2023, spurred by domestic macroeconomic strength, a departure from deflation, and corporate governance reform.

This long-awaited resurgence and the possibility of a once-in-a-generation re-rating for Japanese assets has led to a meaningful shift in investor sentiment. The Tokyo Stock Price Index (TOPIX) hit its highest point since 1990 in mid-September and foreign investments into Japan continue to rise. The outlook for the world's third-largest economy looks more favorable than it has in many years. We believe long-term investment success in Japan requires a strategic approach; one that looks beyond near-term dynamics and considers a range of macroeconomic scenarios, domestic tailwinds, and secular trends. Active investing across public and private markets may prove rewarding if it's combined with on-the-ground expertise and an understanding of Japanese business practices.

Japan finds itself in a domestic demand recovery characterized by an unfamiliar yet desirable cycle of rising prices and wage growth. Inflation is hitting levels that have not been seen since the early 1980s and has even exceeded the Bank of Japan's (BoJ) 2% target; welcome news for an economy which has remained stagnant and faced deflation for a long time. Higher food and energy costs fueled the initial inflation ascent—consistent with global trends—but price increases have broadened out as 2023 has progressed.

Services prices, for instance, have accelerated sharply, reflecting the strong increase in hotel demand amid recent re-opening momentum and the recovery in travel-related consumption. Rail fares, delivery fees and restaurant prices have all climbed higher. Simultaneously, Japan's “Shunto” negotiations between labor unions and companies have resulted in negotiated wage hikes well above usual levels. Data suggest the base pay rise (+2.12%) agreed in spring is the largest since 1992 and headline wage growth (+3.58%) is the highest since 1993.1 The extent to which this wage growth will lift inflation is a key factor for monetary policy going forward.

The BoJ has long viewed a virtuous cycle between wage growth and rising prices as essential for achieving its inflation target in a sustainable manner. It remains too early to tell whether the BoJ's desired virtuous cycle has been achieved. There has yet to be a fundamental reversal in the direction of monetary policy, which remains ultra-easy.

However, we believe strength in underlying inflation—as confirmed by July and August Tokyo core CPI inflation data—supports the case for a gradual normalization of policy over the coming year, including an exit from negative interest rates. That said, we think the risk of large upward or downward swings in inflation still warrant attention. The biggest upside risk is an uncontrolled wage-price spiral, a positive feedback loop between rising wages and prices.

On the other hand, extensions of government energy subsidies represent a downside risk to inflation. In August, Prime Minister Kishida announced plans to expand gasoline subsidies and extend them until the end of 2023.2 Longer term, Japan's shrinking and aging population may have the potential to cause either inflation or deflation in the years ahead. Until now, Japan has partially offset deteriorating demographics by raising labor force participation (higher female participation and higher elderly worker participation). But in the coming decade, the impact of a shrinking workforce may exert upward pressure on wages if the labor supply doesn't grow through immigration.

Eventual outcomes may depend on Japan's ability to enact structural reforms to improve labor force participation, as well as the interaction of demographics with other structural forces like deglobalization, decarbonization and digitization. Yield curve control (YCC) measures continue to remain in place in Japan, having been introduced in 2016 to head off deflationary risks and to achieve an inflation target of 2%. This summer the BoJ—now under the leadership of Governor Kazuo Ueda—effectively relaxed its YCC policy by raising the rate for fixed-rate purchase operations from 0.5% to 1.0%. The rationale for the July adjustment was framed around ensuring bond market functioning, but also reflected an acknowledgement of firm inflation and rising inflation expectations. As expected, Japanese government bond (JGB) yields trended higher following the July meeting.

Investors should keep potential implications for global fixed income markets in mind. Higher local bond yields may lead Japanese institutional investors to repatriate capital invested overseas back to Japan. JGB yields remain lower than fixed income assets outside of Japan. But after taking into consideration currency hedging costs—as many Japanese institutional investors do—JGB yields appear attractive in a global context. This points to a shift in asset allocation ahead and we are mindful of the impact on US agency mortgage-backed securities, US Treasuries and Australian sovereign bonds, given the large footprint of Japanese investors in these markets. That said, the speed of repatriation of capital away from global fixed income back to JGBs remains uncertain.

Investors must weigh other potential currency implications of Japan's rising prices and wage growth, particularly in a market which has seen so little of either in the past 30 years. At present, Japanese companies with a high foreign exposure look to be in the most competitive position in decades with the yen trading at levels that have not been seen since the early 2000s. Domestic focused firms, such as consumer goods companies, retailers, and hotels, are also enjoying a long-awaited boost from increased tourism. The weaker yen makes Japan a more affordable travel destination for foreigners, notably Asian tourists. Now that yen movements have become more dramatic than in the past, foreign exchange (FX) sensitivity is an important parameter impacting corporate profitability and investment portfolios. In addition to FX hedging strategies, the key for investors may lie in finding companies with better cost structures, offshore manufacturing and market leading positions as these types of businesses tend to be resilient to exchange rate movements. Active investment managers can position themselves appropriately to ensure minimum impact from FX movements.

Arguably the most powerful game-changer for Japanese equities in recent years has been increased momentum of corporate governance reform. This is a key part of the “third arrow” of structural reforms first introduced when former Prime Minister Abe came into power for a second time in 2012. The Tokyo Stock Exchange (TSE) continues to focus on boosting corporate value to make Japanese stocks more compelling for investors who have long regarded Japan as a "value trap"—a market that appears attractively underpriced but fails to move toward value. One of the TSE's motivations for reform appears to be the key structural differences between the TSE Prime market and other developed stock market indices in terms of price-to-book value ratios and return on equity distributions. Japanese companies are becoming better stewards of capital and are committing excess cash to record levels of buybacks and dividends. This is attracting foreign investors back to Japan's public equity market.

The TSE is also encouraging more retail investor participation. Only 11% of Japanese household assets are invested in equities versus 20% in Europe, and almost 40% in the US.3 Going forward, further efforts to boost corporate valuations, combined with rising retail and foreign investor demand, could reinforce any upward trajectory of stock prices. Pressure on companies that do not comply with TSE guidelines has been steadily increasing. Insufficient disclosures and explanations about areas of non-compliance, or a lack of urgency about meeting listing requirements, are now being actively highlighted as areas of concern.

Companies are seeing not only pressure from the TSE, but also from investors, given increasing activist activity and investor engagement to improve management through stewardship. There is also a growing consensus about the negative implications inherent in cross-shareholdings ownership, or inter-corporate shareholding, which has been a common practice in Japan. From a capital efficiency and corporate governance standpoint, foreign investors have often emphasized that this is a key area where capital management should be improved. Taking action to avoid negative consequences can be a powerful motivator in any corporate culture, but this appears to be particularly true in the case of Japan.

Data suggests more listed companies are following TSE guidelines by presenting cost of capital calculations and outlining initiatives to boost corporate value; those that did fared particularly well during 1Q 2023 earnings season.4 Looking further ahead, corporate transformation in Japan will create winners and losers, with some management teams proactively seeking to use governance reforms as a channel to achieve sustainable growth, while others fail to keep up. As active, long-term investors in Japan's public equity market, we see the next few years as an interesting time to potentially benefit from this meaningful differentiation and continue to focus on identifying strong management teams with shareholder friendly track records.

Corporate governance reform momentum is also fueling activity in Japan's private equity (PE) market, which has grown significantly in recent years with approximately $20 billion in deal value annually, driven by larger transactions. Dealmaking by private equity funds in Japan roughly doubled in the first six months of 2023 compared with a decline of roughly 40% in the Americas and 65% in Europe, albeit from a smaller base. Approximately half of Japan's public equity market continues to trade at book value despite the TOPIX's surge.

As a result, take-privates and carveouts are being circled by general partners (GPs); the $14-billion take-private deal for Toshiba early this year could prove to be a harbinger.5 Japanese corporations often have a less-focused portfolio than their global counterparts, suggesting certain businesses have the potential to thrive more under independent management. The momentum behind divestitures may continue given the ongoing improvements in corporate governance and transparency.

Japan is not home to an abundance of high-growth innovators and disruptors. But it has several unique technology companies with vital roles in automation, digitization, semiconductors, electronics supply chains and advanced healthcare. Many are not well-represented by Japanese indices which continue to have significant aggregate exposure to cyclical and low growth areas such as auto manufacturers, banks, commodities, transportation, and telecom companies. These top industries make up more than 70% of the TOPIX by weight.7 Some of these sectors were prominent a few decades ago, but these are no longer the areas with the highest future growth potential. Just below this top tier in terms of size, we see many high-quality, long-term growth opportunities. This contrasts with other developed markets like the US, where the indices and markets tend to be led by the faster growing areas of the market.

Japanese equities have shown one of the lowest degrees of long-term correlations with both developed and emerging market indices, driven by the uniqueness of domestic economy and corporate landscape. In our view, the key to investing in Japan will lie in identifying companies that are underrepresented within indices but that are aligned to structural growth trends, and capable of outperforming over the long-term. We believe that active managers in Japan can provide a better forward-looking exposure while limiting allocation to legacy low-growth sectors.

Despite being home to one of the largest stock exchanges in the world, Japanese equities have largely been out of favor for many investors and under-researched, with no analysts covering 45% of the TOPIX. By comparison, only 3% of the Russell 3000 Index (a proxy for the US equity market) lacks analyst coverage. For investors with strong research capabilities, a local presence and deep understanding of accounting standards and cultural factors—including cultural conservatism, deeper and longer-term corporate business relationships—we see Japan as fertile ground for alpha generation through active management. In contrast to many other markets, the investment landscape in Japan has historically boded well for active equity managers over time with the minimum annualized alpha for top-quartile players amounting to +472 bps and +193 bps over trailing 3- and trailing 5-year periods.8 In today's highly uncertain world, the impact of strong, consistent alpha generation is likely to be more pronounced than ever before.

Delivering strong and consistent returns also requires investors to identify regional and global geopolitical risks and embrace potential opportunities where they can be found. With conflicts between countries and competition for national interests becoming more pronounced, Prime Minister Kishida has committed to reinforce Japan's defense capabilities, noting cybersecurity and digitalization as increasingly important areas for national security.9 Many Japanese businesses already hold leading positions in materials and precision manufacturing, robotics, and factory automation—sectors that are likely to see strong demand as global supply chains realign and companies seek efficiency gains.

The backdrop for Japan's semiconductor industry also looks favorable with US trade restrictions on China and global semiconductor supply chains being rebuilt. Some of world's largest semiconductor makers have announced plans to deepen tech partnerships in Japan following moves by the government to provide subsidies for domestic chipmaking. This may complement the country's already advanced standing semiconductor packaging and substrate technologies—increasingly important areas given future technological trends like artificial intelligence (AI) rely on improved semiconductor performance.

In some areas, private capital may be advantaged by its ability to provide a long-term, patient investment that reacts less to near-term geopolitical gyrations. On the other hand, public market investors with the ability to draw on both global intellectual capital and on-the-ground expertise in Japan may also be able to navigate uncertainty and generate long-term outperformance.

Japan's economic revival and intense focus on improving governance standards have captured investors' attention and may provide a powerful tailwind for corporate earnings in the years to come. In the near term, we expect earnings to remain resilient driven by a weaker currency, rising inbound tourism, strong corporate capex and other positive long-term structural changes that are underway. However, we expect the upcoming quarters to be key in determining whether the recent macroeconomic and market resurgence can turn into a more permanent positive reality for Japan.

If both consumer and corporate activity changes in line with a shift from a deflationary to an inflationary mindset, this would likely have positive long-term implications for business, investment, and growth. Over the long-term, investment success in Japan may require an active investment approach across public and private markets. Japan seems on the cusp of a new dawn. Investors that focus on companies that are both secular growth winners and committed to corporate reforms may end up on the right side of change.