How to revive moribund stock markets

While much of the world either slipped into a recession or skirted with one over the past two years, the US avoided one with its strong consumer spending and healthier corporate balance sheets than its overseas peers.

A strong stock market was the key.

Larry Fink, CEO of asset management behemoth Blackrock, noted in his annual shareholders letter in March that strong capital markets help build more prosperous economies.

Not surprisingly, “more and more countries recognise the power of American capital markets and want to build their own”, he said.

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As part of his efforts to make Paris a global financial hub, President Emmanuel Macron has gone to great lengths in trying to copy the success of US markets.

The French leader has long been a big proponent for better integration of capital markets across Europe to mobilise private cash for the investment needed in cutting-edge technologies like artificial intelligence.

From 1980 through to 2009, European stocks were neck and neck with US stocks with benchmark indices there growing at a compound annual rate of 11.49% per year compared to 11.51% for the US barometer S&P 500 index.

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Since the lows of March 2009, however, while European stocks are up just 150%, the S&P 500 is up eight-fold.

America’s success since the financial crisis in 2009 has largely been due to the breadth and depth of its capital markets.

Over the past 12 months, US stocks are up 24%, including dividends, while European stocks are up over 15%.

There are over 60 stock exchanges and in the winner-takes-all world of stocks, the US is the far-and-away leader.

In early 2008, American stocks accounted for 38% of total global market value of all listed stocks.

They currently make up about 62% of total global market capitalisation.

Total market capitalisation of publicly traded US stocks touched US$50.8 trillion ($66.2 trillion) last year.

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That has since grown to US$60.7 trillion, up from US$13.3 trillion at the end of 1998.

Incidentally, the number of listed companies in the US shrank from 8,100 in early-1997 to under 4,000 currently.

In contrast, the number of listed companies in Asia, and Latin America are up sharply over the last 27 years while the total market capitalisation in US dollar terms is either down or up marginally

Here is the thing: In Asia, Latin America and Europe, wealth has traditionally been concentrated in low-yielding, low-margin, low-growth, asset-heavy sectors like real estate, while in the US, the corporate sector is propelled by more efficient, innovative, asset-light, high-margin, high-growth tech firms.

Capital markets tend to value intellectual property-focused asset-light businesses such as software, e-commerce, and social media platforms more highly than their asset-heavy peers like real estate.

America also has a particular form of capitalism that spawns, creates, and indeed grows ideas and technologies on a global scale.

It has far better corporate governance and management.

If a company’s stock is lagging its peers, boards often move quickly and bring in new leadership, something that boards outside the US are loath to do.

Look no further than the recent firing of Laxman Narasimhan as Starbucks’ CEO and the appointment of Brian Niccol, who until last week headed Mexican restaurant chain Chipotle, as his replacement.

While Niccol was Chipotle’s CEO, its stock rose 773% over six years.

Under Narasimhan’s 15-month reign as Starbucks chief, the coffee chain operator’s stock was down 30%.

That was enough for the board to send him packing.

US boards are ruthless because they care about shareholders.

The hallmark of a strong stock market are boards that kick, not kiss, the CEO’s ass.

Japan’s turnaround

One country that has been fairly successful in reviving its own once moribund stock market is Japan.

Tokyo has made big changes in capital allocation and corporate governance over the past few years.

The key objective of the reforms is to help the Japanese market shake off its reputation as a “value trap”.

The changes helped propel benchmark Nikkei 225 Index to new heights in July — although the recent unwinding of the yen carry trade, following Bank of Japan’s first rate hike in over 17 years, has dampened investors’ enthusiasm.

That said, Japan’s corporate reforms story remains intact.

Early last year, the Tokyo Stock Exchange (TSE) issued a directive asking all listed companies whose stocks were trading at below book value to submit a plan to get them up to at least on a par with book value.

Shares trade below their book value because investors just do not believe in the story the companies are telling.

Here’s how pessimistic investors were about listed Japanese firms: About half of the companies in the Prime Section and nearly 60% of firms in the Standard Section were trading below book value last year.

After TSE issued the directive, companies began posting their plans to boost their share prices including implementing share buybacks, boosting dividends, selling non-core assets, or hiving off or selling low-performing businesses.

Verdad Capital, a Boston-based global asset management firm, reviewed plans issued by 3,200 firms on TSE.

“This is activism at scale — a compelling catalyst for a continued rally in Japanese stocks,” notes Dan Rasmussen, CIO of Verdad.

About 58% of the firms plan to boost dividends, 23% plan to buy back shares and 13% plan to wind down their cross-share holdings or sell strategic holdings, he says. “This is truly widespread change.”

At the forefront are small and medium-sized firms in Japan that have long been neglected by investors even though they are profitable and have strong cash flow.

Among them is T.RAD Corp, a global manufacturer of heat exchangers for cars, air-conditioning units, battery cooling and fuel-cell cooling, which plans to set aside US$70 million to increase dividends and buy back its shares.

Another firm, Toli Corp, a manufacturer of floor and wall coverings and curtains, says it plans to pay US$27.8 million in dividends, and repurchase shares and raise another US$14 million from selling shares in an affiliate firm.

Then there is Neturen, a manufacturer of induction heat equipment and high-strength steel products, which plans to repurchase shares worth around US$74 million next year.

Yet another firm, NPR-Riken, a manufacturer of auto and marine engine parts, told TSE that it intends to buy back shares worth US$70 million and raise another US$20.9 million from the sale of some of its cross-holdings.

And Nippon Seiki, a mid-sized firm which designs and manufactures electronic devices and mechatronics products, plans to increase dividends and buy back shares worth US$174 million over the next two years.

Investors are taking note of what these formerly neglected companies are doing by buying their shares.

Companies that announced plans to sell non-core assets or unwind cross-shareholdings saw their stock prices rise on average 56%, while those that instituted share buybacks saw an average increase of 46%.

Those that announced increased dividends saw their stocks soar an average 41%.

Just over 30% of the stocks listed on the Prime Section of TSE are now trading below book value.

TSE has begun naming and shaming firms that are not improving corporate governance and have yet to unveil plans about how they intend to get their shares above book value.

The key is not just announcing a plan to buy back shares or intention to increase dividends, but actually taking action to execute the plan.

Firms that have made an effort to lay out a specific and tangible action plan to help their shares trade above book value have experienced a significant rise in their stock prices since TSE’s announcement, more than double compared to firms that have not done so.

The market has generally reacted positively to the companies’ disclosed plans, and TSE’s “name and shame” tactic is working so far.

Whether the Japanese market continues to build on its momentum will depend on the willingness of more firms to buy back shares, pay dividends, sell assets and listen to activists and regulators who are trying to increase market liquidity and help capital formation.

Learning from Japan

The neighbouring Seoul bourse, which has perennially suffered from what has been dubbed as the “Korea discount”, earlier this year took a page from Japan’s corporate reforms and unveiled its own “Corporate Value Up” programme to shed that discount.

The Korea discount is largely due to the dominant chaebol, or large opaque family-owned business conglomerates like Hyundai and Samsung.

The chaebol thrived through interlocking shareholdings controlled by their founder patriarchs.

While some have been wound down following family feuds, the chaebol remain debt-ridden, asset-heavy conglomerates with interlocked shareholdings to protect the owning families from losing control of their groups or foreign investors building large stakes.

The chaebol have also been reluctant until recently to buy back shares or pay anything more than a nominal dividend.

A new generation of chaebol leaders, urged on by Korean regulators, are starting to see the benefits of good corporate governance.

They are also more open to foreign institutional investors though still wary of activist shareholders who have unsuccessfully waged battles against them.

Creative destruction is another way to kickstart stock markets.

Economist Javier Milei became President of Argentina last December. Inflation had touched 211% under his Peronist predecessor Alberto Fernández.

Milei wanted a complete overhaul of Argentina to make it an attractive destination for global stock market investors.

He devalued the Argentine peso by over 50% to decrease the country’s fiscal deficit and reduce macroeconomic and trade imbalances.

To cut government spending, he eliminated nine out of 18 federal government ministries, initiated a plan to cut 70,000 public sector jobs and froze over 2,700 public works projects.

Milei has also rolled back energy and transport subsidies.

The MSCI Argentina Index ETF is up 70%, in US dollar terms, since he won the first round of elections last November, and over 35% since he took office a few weeks later.

Global investors are flocking to Argentina for the first time in decades.

Exchanges in Singapore, Kuala Lumpur and Bangkok should focus not on getting more firms listed but implement reforms the way Japan and Argentina have.

Over 67% of the SGX-listed stocks are currently trading at below book value.

SGX can tackle that by taking a leaf out of TSE’s reform playbook. Yet talk is cheap.

Macron talked a good game but the Paris bourse is still awaiting reforms.

France is home to just one big global company, luxury goods maker LVMH.

Southeast Asia needs fewer listed companies but ones that ag- gressively buy back their own shares, are more generous in paying dividends and adhere to the highest corporate governance standards.

If need be, SGX should also name and shame recalcitrant firms the way Tokyo has done.

To woo investors, the region needs high-growth, asset-light and innovative tech firms.

That requires a more vibrant venture capital ecosystem, encouraging activist investors as well as short-sellers as key participants.

India has a stronger stock market today because Hindenburg Research waged a relentless battle against Adani Group, the infrastructure giant, early last year.

Activist investors are a vital part of lively capital markets.

You ignore them at your peril.

There is also the need to foster private equity firms to help shepherd local corporates to new heights. 

Assif Shameen is a technology and business writer based in North America