Unlocking the Rising Sun: Exploring the Appeal and Opportunities of the Japanese Stock Market
:Executive Summary: Japan’s stock market is experiencing a surge in 2023, with the Nikkei 225 reaching its highest level since 1990. Contributing factors are attractive valuations, the return of moderate inflation, a weakening currency, unique monetary policies, and decent corporate governance.
After a wait of more than three decades, Japan's stock market is finally experiencing a moment in the sun. Despite some initial setbacks caused by banking sector shocks in March, the Japanese stock market has rebounded strongly and is now approaching all-time highs.
One of the key factors contributing to this surge is the relatively "cheap" valuations of Japanese stocks. Combined with a long-awaited return of inflation and a weakening currency, these conditions have propelled the Nikkei 225 index to surpass 33,000, reaching its highest level since 1990. However, it is important to note that past performance is not a reliable indicator of future results. Another boost to the Japanese stock market came in the form of an endorsement from Warren Buffett, one of the most successful investors in history. Buffett has held a favorable view of Japan for many years, as many Japanese companies exhibit the traits and characteristics that align with his preferred investment approach of value investing. His entry into the Japanese market in April acted as a catalyst, inspiring others to follow suit.
In May 2023 alone, investors poured over $15 billion into Japanese stocks, marking the highest monthly amount since October 2017. However, caution is advised, as these rapid movements raise concerns about whether this is merely a momentum trade or if a potential "bubble" could be looming on the horizon.
The recent resurgence of the Japanese stock market is also attributed to significant changes in the Tokyo Stock Exchange, representing the largest overhaul of equity markets in Japan in over a decade. These changes aim to enhance the overall governance standards of listed Japanese companies, with a stronger focus on shareholder returns. This improved perception of corporate governance may lead to increased investor confidence and attract foreign investment.
Moreover, Japan stands out as an outlier among major global economies due to its approach to inflation and interest rates. While many other economies grapple with surging inflation, Japan has embraced it after years of deflation. The Bank of Japan has maintained interest rates below zero, in contrast to other central banks that are rapidly hiking rates. Consequently, borrowing costs for Japanese businesses remain low, which has the potential to stimulate growth. This ultra-loose monetary policy further supports economic expansion.
Additionally, Japanese companies have begun increasing prices for the first time in decades, and the country's gross domestic product (GDP) grew by 0.4% in the first quarter of 2023. Although these measures have been instrumental in Japan's economic recovery, the weakening of the yen has made imports more expensive. However, this depreciation has bolstered exports, making Japanese goods relatively cheaper in the global market—an advantageous position for a major exporting nation like Japan.
Considering the attractive valuations, there are potentially intriguing opportunities and hidden gems within the Japanese stock market. Some segments of the market remain misunderstood and under-researched, creating prospects for investors to uncover untapped potential.
Overall, Japan's stock market resurgence is driven by a combination of factors, including favorable valuations, the return of inflation, a weakening currency, improved corporate governance standards, and unique monetary policies. While the market's recent performance is encouraging, investors should exercise caution and conduct thorough research to navigate the potential risks and identify the opportunities presented by this evolving landscape. Japanese shares are experiencing a flourishing year in 2023, with the Topix and Nikkei 225 indices reaching their highest levels since 1989 in May. While gains have been tempered for overseas investors due to a weaker yen, Japanese equities have outperformed other developed markets. The growing enthusiasm for Japanese shares can be attributed to two key factors: Firstly, there is a cyclical aspect driving the momentum. Japan's economy has been relatively late in reopening after the Covid-19 pandemic, which instills confidence in corporate earnings growth for this year. Additionally, the Japanese stock market as a whole presents attractive valuations, further bolstering investor sentiment.
Secondly, a more significant development with long-term implications is the Tokyo Stock Exchange's call earlier this year for companies to focus on achieving sustainable growth and enhancing corporate value. This call specifically targeted companies with a price-to-book ratio below one, highlighting the importance of improving valuations for Japanese companies.
Reopening post- Covid The reopening of Japan post-Covid also contributes to the upward trend in Japanese shares. The country experienced longer periods of pandemic restrictions compared to the United States and Europe. The reopening of borders to foreign tourists in October 2022 and the recovery of domestic travel benefit smaller, domestically focused companies operating in sectors like travel, leisure, and hospitality.
Furthermore, the delayed lifting of pandemic restrictions in China, a significant trading partner for Japanese companies, also plays a positive role in supporting Japanese shares. Chinese tourists constituted a substantial portion of total visitors to Japan, and the belated reopening of China post-Covid strengthens the outlook for Japanese shares.
Welcome return of inflation
In addition to these factors, another key driver behind the growing enthusiasm for Japanese shares is the welcome return of inflation. After three decades of low inflation and even deflation, Japan is experiencing a mild inflationary period. This shift from deflation to inflation is highly beneficial for the Japanese economy. Deflation tends to discourage investment and consumer spending, as people anticipate lower prices in the future. Conversely, moderate inflation instills confidence in companies to invest and consumers to spend, fostering corporate growth, wage increases, and higher consumer expenditures.
In summary, the strong performance of Japanese shares in 2023 can be attributed to the cyclical aspect of the late reopening of the Japanese economy, attractive valuations, the Tokyo Stock Exchange's call for sustainable growth, the recovery of domestic and Chinese tourism, and the welcome return of inflation. These factors collectively contribute to a positive outlook for Japanese equities, with the potential for sustained periods of higher corporate investment, wage growth, and increased consumer spending.
Japan CPI/Inflation Rate
Source: (tradingeconomics.com | Statistics Bureau of Japan)
Source: (tradingeconomics.com | Statistics Bureau of Japan)
Japan’s Allure Endures: A Look at its Position as One of the Cheaper Stock Markets
Sources: Datastream Refinitiv, MSCI and Schroders Strategic Research Unit. Data to 31 May 2023.
Figures are shown on a rounded basis. Assessment of cheap/expensive is relative to 15 year median. 608990.
Japan Stock Market Index (JP225)
Source: tradingeconomics.com
Sector Trends
Source: Simply Wall Street (2023)
Source: Simply Wall Street (2023)
BOJ’s Curveball: Unexpected Shift in Yield Curve Policy Sends Ripples Across Markets Curve Markets
On December 20th, 2022; the Bank of Japan (BoJ) made significant changes to its approach in controlling bond yields as part of its monetary policy adjustments. The BoJ's previous target was to maintain a 0% interest rate for its ten-year bonds, with a permissible deviation of up to 0.25% from the target. However, while the 0% target remains unchanged, the BoJ has now widened this permissible limit to 0.5%, allowing the interest rate on these bonds to rise. This move represents a subtle tightening of the money supply within the country.
Simultaneously, the BoJ also announced its intention to increase bond purchases, signaling a loosening of fiscal policy. This combination of higher rates and increased bond purchases has led many experts to view the BoJ's actions as an adjustment to its monetary policy rather than a strict tightening.
The change aims to enhance the sustainability of the monetary policy framework. He emphasized that it is not a shift away from yield curve control (YCC) or a signal of an imminent exit from the accommodative policy. Overseas market volatility intensified from around spring as a primary reason behind the adjustments. While the BoJ had maintained the ten-year bond yield below the 0.25% cap, this approach caused some distortions in the yield curve's shape. Thus, the bank concluded that the timing was appropriate to address these distortions and enhance market functionality.
In response to the news, the value of the yen surged, and Japanese stocks experienced a decline. Investors reacted with concerns that this move might signify the beginning of a series of rate increases. However, BoJ’s reassurances aimed to alleviate such anxieties, emphasizing that the actions were aimed at maintaining a balanced approach to monetary policy.
Overall, the BoJ's latest decisions regarding bond yields and fiscal policy demonstrate its efforts to adapt to changing economic conditions and maintain a flexible approach to supporting Japan's economic growth.
Responding with Caution and Adaptability: Navigating the Waves of Recent Market Movements
The global economy's interconnectedness means that policy changes in one part of the world can have significant impacts elsewhere. With inflation in Japan exceeding the 2% target set by the Bank of Japan, there are concerns about potential tightening measures to combat inflation. Japanese bank shares rose more than 5% on this announcement, indicating a sentiment shift toward the end of the era of low-interest rates.
As Japan is the world's largest creditor, fiscal policy tightening could prompt foreign investors to withdraw their investments, leading to falling asset prices and rising rates in other economies. Investors are closely monitoring the Bank of Japan's actions going forward, and further policy adjustments may be delayed due to the strong market reaction. Additionally, with Governor Kuroda's term set to end soon, there is uncertainty about potential economic policy changes under a new governor's leadership.
Amidst the interlinked global economy, policy changes on the other side of the globe can reverberate with significant impacts back home. Japan, being the world's largest creditor, holds a pivotal role in the international financial landscape. The recent move by the Bank of Japan to tighten its yield curve policy, given the persistent inflation above the 2% target, has sparked concerns and market reactions worldwide.
In response to the uncertainty brought about by the tightening measures, ABP Investment Committee which previously allocated 9% to the Japanese asset class in December 2022, have taken prudent measures. Recognizing the turbulence in the current economic environment, ABP Investment Committee has decided to reduce the weightage to the Japanese asset class to 7.6%. This strategic adjustment reflects the cautious approach adopted by investors as they navigate through the potential impact of Japan's policy changes on global financial markets.
As the situation evolves, many investors will closely watch the Bank of Japan's actions and communications going forward. The market will remain vigilant, assessing the effectiveness of Japan's efforts to control inflation and the implications for the broader economic landscape. Furthermore, the upcoming change in leadership at the Bank of Japan with Governor Kuroda's term ending in the first half of the next year adds an additional layer of uncertainty to the economic policy outlook. In the face of these intricate global dynamics, strategic portfolio reallocations such as the one taken by ABP Investment Committee signify a proactive stance in adapting to changing market conditions. As financial markets remain sensitive to policy shifts and economic indicators, investors must exercise vigilance and agility to safeguard their portfolios and navigate these turbulent times successfully. Japan’s Asset Class Performance in ABP Portfolio/s:
Source: Morningstar Direct
Percentage Allocation in the AB4 Portfolio since Inception: Between 9.5% and 12.54%
Contribution of Japan Funds in AB4 Portfolio’s Total Returns (Since Inception): 1.91%
1-year return (01/07/2022 to 30/06/2023): 12.70%
Source: Morningstar Direct
MPORTANT NOTICE: This is a marketing communication from Alpha Beta Partners a trading name of AB Investment Solutions Limited. Registered in England at Northgate House, Upper Borough Walls, Bath BA1 1RG. AB Investment Solutions Limited is authorised and regulated by the Financial Conduct Authority. Reference No. 705062. This material is directed only to Financial Advisers in the UK and is not an offer or invitation to buy or sell securities. Opinions expressed, whether in general or both on the performance of individual securities and in a wider context, represent the views of Alpha Beta Partners at the time of preparation. They are subject to change and should not be interpreted as investment advice.
You should remember that the value of investments and the income derived there from may fall as well as rise and your clients may not get back the amount that they have invested. Past performance is not a guide to future returns.