Japan’s stock market has waited more than three decades for its moment in the sun.
The country’s major stock indexes are trading at highs not seen since 1990, when its infamous asset bubble of the late 1980s was just deflating.
So far this year, the benchmark Topix has jumped almost 14%, and the Nikkei 225 (N225), which tracks Japan’s blue-chip companies, has leapt nearly 17%. The indexes have outpaced the United States’ S&P 500 and Europe’s Stoxx 600 benchmark indexes, which have both risen 8% in that time.
“In my 33 years in the market, things do seem probably more positive now than they’ve seemed at any time in that whole period,” said Jeffrey Atherton, an investment manager at Man GLG, a subsidiary of hedge fund giant Man Group. “It’s not based on hype.”
Investors say Japanese stocks have benefited from relatively cheap valuations, a long-awaited return of inflation, and a weakening currency.
An endorsement by Warren Buffett probably didn’t hurt either — the legendary investor told Japanese publication Nikkei in April that his flagship investment firm, Berkshire Hathaway, planned to increase its holdings in five Japanese companies.
Foreign investors bought $15.6 billion worth of Japanese stocks last month, the highest monthly amount since October 2017, according to the Japan Exchange Group.
For years, investors have hoped modest rallies in Japanese stocks would translate into a sustained market revival for the world’s third-largest economy, which is also home to a raft of household-name electronics companies and carmakers, like Sony (SNE) and Toyota (TM). But they never did.
But this time, investors tell CNN, really is different.
Change from the top
Japanese stocks have received their biggest bump from an overhaul of corporate governance rules that has compelled company executives to improve shareholder returns. JPMorgan analysts said last week that the “structural change” taking root in Japan could give the current market rally “staying power.”
Earlier this year, the Tokyo Stock Exchange began telling companies to pay more attention to their stock price. It urged them to come up with plans to boost their price-to-book (PTB) ratios — that is, the firm’s share price relative to its net assets.
Half of companies listed on the Tokyo Stock Exchange trade at a PTB ratio of less than one, according to Man Group data from February, compared with just 3% of firms on the S&P 500.
A low ratio means the stock is a bargain. The problem is that at least half of Japan’s companies have been stuck trading at a ratio of below one for most of the past 20 years. As a result, there has been little incentive for investors to buy the stocks if they don’t believe they can sell them at a higher price later on.
“There’s long been a lot of undervalued companies in Japan,” Atherton noted. “We take it for granted in the US and Europe that corporate management is trying to maximize the share price, but that’s by no means been the case in Japan for the last 30-odd years.”
That may now be changing.
Companies tracked by the Nikkei index paid out record dividends in 2022. At the same time, a spate of share buybacks has helped swell stock prices.
Japanese firms bought back 9.7 trillion Japanese yen ($7 billion) worth of their own stock in the fiscal year ending March 2022, according to Frank Benzimra, head of Asia equity strategy at Societe Generale. That’s the most since he started tracking the data 24 years ago.
For the 2023 fiscal year, share buybacks have totaled around 8.6 trillion Japanese yen ($6.2 billion). That number could rise because a few companies are still to report their earnings.
Inflation is back
A recent spate of encouraging economic data in Japan has lifted investors’ spirits, while a weakening currency has made the country’s exports more competitive.
What central banks in other major economies have been fighting over the past year — soaring inflation — has been welcomed by Japan’s policymakers.
Following decades of deflation, the country’s consumer prices rose in January at the fastest annual pace in 41 years. Inflation has since slowed down a little, but remains well above the Bank of Japan’s 2% target.
Still, the central bank has kept its main interest rate below zero while its counterparts in the United States, United Kingdom and the European Union have jacked up borrowing costs at a record clip to keep prices in check.
“[Japan] is an economy where policymakers have been beating on the inflation beehive for decades, hoping the bees would come out,” Jack Ablin, chief investment officer and founding partner of Chicago-based Cresset Capital Management, told CNN. “And now it appears, finally, they’re getting the inflation.”
That difference in monetary policies has driven down the value of the Japanese yen against most other major currencies. The currency has fallen almost 9% from a year ago to trade at 139 to the US dollar — “table-poundingly cheap,” according to Ablin. A weaker currency makes the country’s exports relatively cheaper on the world market, a particular boon for a major exporting nation like Japan.
Japan’s improving economic fortunes have also made its companies more attractive.
Gross domestic product grew 0.4% in the first quarter this year compared with the last three months of 2022, beating analysts’ expectations of a 0.1% bump.
Activity in Japan’s private sector also grew in May at the fastest pace since late 2013, according to preliminary PMI data from au Jibun Bank, a Japanese lender, compiled by S&P Global Market Intelligence.
Challenges ahead
Japan’s economy still faces some enormous hurdles. It has a rapidly aging population — almost one-third of its people are over the age of 65 — and a shrinking labor force, not helped by the government’s restrictive stance on immigration.
More immediately, the country’s market rally could stall if the US Federal Reserve decides to put a brake on its rate hike cycle, says Eddie Cheng, head of international portfolio management at Allspring Global Investments.
“We have already seen US kind of getting into the peak of their hiking cycle,” he said, adding that if central banks began to cut rates, the value of their currencies would fall, meaning the Japanese yen would be “no longer cheap” by comparison.
