What’s the story?
Japanese equities offer quality large caps, the market is highly liquid, and with recent share buy-backs investor perceptions are changing. Additionally, corporate reform remains a powerful force for unlocking value in the Japanese stock market.
We upgraded Japanese equities to Overweight in October 2023, foreseeing a transformative wave driven by corporate reform, Japan’s evolving role as a ‘China alternative’, and greater retail investor participation. Since then, Japanese equities have hit all-time highs, with the first two of these dynamics materialising. And while the influx of Japanese retail investor flows is still pending, this will soon be facilitated by the revamped tax-advantaged Nippon Individual Savings Account (NISA) programme, which is set to bring a significant amount of retail funds into the market.
What makes Japan so attractive to investors?
After 34 years, Japan’s stock market has hit new highs and is set to continue on its growth trajectory, but what makes it so attractive and why now?
1. Corporate reform
Corporate reform has gained significant momentum since 15 February 2024, with regulators showing that 54% of companies have disclosed initiatives to reduce the cost of capital and enhance valuations (as at 31 January 2024). These endeavours are poised to unlock latent value embedded within Japanese equities. The strong investment case for Japan is also reflected in the record number of private equity deals (according to Bain & Company) and a record number of share buy-backs, with the number of companies announcing buy-backs exceeding 1,000 in 2023, for the second year in a row. Share splits are increasingly common with fiscal year 2023 announcements coming in at 60% higher than the previous year. This lowers the investment quantum for retail investors to participate in the stock market.
2. Foreign investors are still underweight
Starting from Warren Buffett’s Berkshire Hathaway in 2019 to Chinese retail investors looking for an alternative to their market this year, there is plenty of flow into Japanese equities. Still, our analysts point out that foreign investors as a group now hold USD 100 billion (as at 31 December 2023) more than they did 10 years ago. As a result, plenty of global investor flows can still find their way into a reformed corporate Japan.
3. Deep market breadth and quality
Japan’s market has the largest average daily trading volume in Asia after China’s onshore market, surpassing even Hong Kong. Its depth and breadth could attract more significant international funds, potentially closing the gap with the leading Chinese exchanges. In addition, investors can find leading quality companies in Japan that have global platforms and products.
4. A tourist destination
Japan’s tourism numbers are rapidly approaching pre-pandemic levels, with nearly 2.7 million visitors in January 2024. Increased international flights and a temporarily weak currency are making travel to Japan more affordable. The country has also seen an increase in visitors from the US, Europe, Australia, and the Middle East, offsetting the decline in Chinese tourists.
5. A geopolitical sweet spot
Japan seems to be in a sweet spot in what is likely to be a protracted period of tension between the US and China. At the same time, Japanese companies are in many cases leaders and shapers of their industries and are therefore likely to be in demand from both China and the US.
Interest rates and the Japanese yen
Monetary normalisation in Japan, coinciding with interest rate cuts in the Western world, are likely to lead to a stronger JPY. A rise in the JPY makes equities more valuable to non-JPY investors, potentially providing an additional source of performance for foreign investors. Moreover, in more than half of the years in which the JPY has appreciated over the past half-century, Japanese equities have ended the year higher. This shows that even though over 20% of Japan’s GDP comes from exports, and a stronger JPY makes exports less competitive globally, global investors need not necessarily fear a stronger JPY. Zooming out, even if the yen did appreciate, we expect it to do so gradually and still be very competitive compared to the start of 2022 when the yen was at 114 vs the US Dollar.
What does this mean for investors?
We see a number of opportunities in Japanese equities, which, beyond their cyclical nature, are now supported by the winds of change in the corporate landscape. This should lead to higher profitability and better valuation after a long period of stagnation. All this should add up as a magnet for further inflows from domestic and international investors alike who are in search of alternatives to Chinese assets.