Why big investors have fallen in love with the Japanese stock market after more than 30 years
The Asian country’s market is at its highest thanks to a favorable economic, business, and political context
It has taken thirty-five years for the Japanese Stock Exchange to escape the pernicious effects of the country’s financial bubble that burst in the late 1980s. The Nikkei 225 index has returned to historical highs above 40,000 points, after a long journey of deflation, negative rates, and continuous intervention in the financial markets by the Bank of Japan (BOJ) through buying bonds and stocks.
Last year inflation returned to that Japanese economy, and it is expected that this year, at last, the BOJ will raise interest rates, which have been anchored at –0.10% since 2016.
“After three decades of low prices, and even of deflation, moderate inflation is welcome in Japan. Deflation leads companies and consumers to delay investment and postpone purchases. There is little point in buying something now if it will be cheaper tomorrow. On the other hand, moderate inflation gives companies confidence to invest in the future and encourages consumers to spend,” explains Alex Tedder, head of global equities at Schroders.
But this return to inflation is not the only reason for analysts’ optimism about the resurrection of a Japanese stock market, which has been ignored for many years by international money is now becoming fashionable once again. The fact is that foreign investors have been underweight in Japan for much of the last twenty years.
Interest from foreign investors’ was already evident in 2023, when the influx of foreign investment flows into the Japanese equity market became the largest in ten years. “Japan has benefited from the arrival of global investors who are diversifying their investments in Asia. Geopolitical tensions and slowing growth have caused a pivot from China to Japan,” says Aneeka Gupta, director of analysis at WisdomTree.
Dan Carter, an investment manager at Jupiter AM, concurs: “In general, global investors are deemed underweight the market, which means outperforming is painful for their portfolios. Part of this underweighting is being corrected. The exodus of shareholders from the Chinese market, until not long ago a favorite destination for global investors, has meant that capital is looking for a new home,” he concludes.
The market’s valuation and the business benefits support the gamble. “They are trading at 13 times expected earnings (PER), compared to 20 times the US S&P 500. Furthermore, we forecast earnings per share growth for Japanese stocks to be 6.2% in 2024, outperforming all the other developed markets,” explains Luca Paolini, a strategist with Pictet.
It is an improvement in business profits that is also supported by the weakness of the Japenese yen, which has increased exports. For example, Japanese imports decreased 9.6% annually in January, while its exports grew 11.9%. The yen has lost half of its value against the dollar in the last twenty years, making its economy more competitive and without supporting the unwanted effects of price growth in imported products.
A fact that also highlights the attractiveness of Japan compared to Western markets is the greater diversification in the activity of the companies that make up its main indices (Topix 500 and Nikkei 225), compared to the excessive concentration on technology that the American markets suffer.
Despite this, the Japanese economy is in recession after the last two quarters of last year showed negative growth, despite growing 1.9% for the year as a whole. This has meant ceding third place in the world’s largest economies to Germany. However, the prospects for 2024 are encouraging and the Bank of Japan itself expects the year to end with growth of 1.3%.
There is also a political will to stimulate the stock exchanges, both on the part of companies and local investors. The Japanese government is adopting measures to modernize its business fabric and prioritize the interests of shareholders. “At the end of 2022, a statement was issued urging Japanese companies to return money to owners, either through share buyback programs or the distribution of higher dividends. There has already been an initially strong response from companies, and we hope that the trend will continue,” comments Tedder from Schroders.
Stimuli
Capital Group analysts point to other initiatives that have made listed companies more attractive. “In March 2023, the Tokyo Stock Exchange asked companies to improve profitability, long-term results, and valuations. The aim is for the company to generate a return on equity greater than its cost of capital. The different ways to achieve this include reducing excess liquidity on the balance sheet and eliminating less profitable subsidiaries,” they explain.
And the other leg of this stimulus is that the savings of the Japanese go to the market. “Japan is transforming into an asset management-led nation under the leadership of Prime Minister Kishida. In an effort to unlock nearly $14 trillion of household financial assets tied up in cash deposits,” explains Aneeka Gupta. And she adds: “The features of the Nippon Individual Savings Account (NISA) have been reviewed, which offers tax advantages and portability. Starting in 2024, the maximum investment amounts allowed in the NISA have been increased and investors can enjoy the system’s tax advantages permanently.”
Therefore, there is a favorable economic, business, and political context for the Japanese stock market. And it seems that the honeymoon with investors will last. BlackRock believes that the rally in Japanese equities still has some way to go, unlike the false starts that were seen in the past. “Both the macroeconomic outlook and evolution among Japanese companies will drive the next upward leg. We believe that the BOJ will cautiously withdraw its ultra-loose monetary policy so as not to disturb the exit from decades of deflation, and we maintain our overweight rating in Japanese securities,” they conclude.
Keep an eye on salaries
The aging of the population is one of the keys to the Japanese economy. The phenomenon causes strong tensions in wages due to the shortage of labor. In the coming days, negotiations for the 2024 wage increase will be completed. Raphael Olszyna-Marzys, economist at J. Safra Sarasin, says that the Bank of Japan has placed a lot of emphasis on salaries. The phrase “virtuous circle between wages and prices” appears in many of their recent reports, pointing to the possibility that higher wage increases will simultaneously support spending and force companies to raise prices to protect their margins. “This would mean a clear break with the period that began in the late 1990s, when the freeze on wages and prices became the norm.” And he continues: “Several large companies, such as Asahi Beer, Mizuho, and Mitsui Estate, have already announced salary increases of 6% or more.” The higher the salary, the more purchasing power and the more growth.
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