The Japanese Nikkei shined last year as one of the most profitable markets in the world, with a rise of 28.2%, and by the beginning of July it had accumulated a revaluation of 26%. Nothing then suggested that after less than a month it would suffer its biggest drop since 1987, with a 12.4% drop. This Black Monday exemplifies the slap in the face of reality and the adjustment of expectations that investors are having to deal with these days, after the weakness of the yen, the basic ingredient on which the rise of the Japanese stock market has been based, has become evident. Managers are now resetting their bet on Japanese equities, which remain attractive in the long term but which will hardly be able to count on its currency as an inseparable ally to sustain its advances.
Last week, the Japanese stock market closed with a cumulative decline of 2.46%, largely recovering the ground lost in Monday’s session. On Tuesday itself, it recorded a notable recovery of 10.23%, although the shock has been so great that it leaves what has so far been an obvious bet for diversifying portfolios in 2024 in a bad mood. The main cause of concern from now on for investment in Japan will be the evolution of the yen and the decisions of its central bank. The Japanese market has been exploiting for months the advantage of a weak currency and the gap in interest rates between Japan and the rest of the Western economies. A difference that promises to narrow: the Fed is going to lower rates, foreseeably faster than expected, and the Bank of Japan wants to continue raising them, up to 1% if inflation allows it.
Japan was left out of the monetary tightening that the US and the eurozone undertook in 2022 to curb inflation. With an economy burdened for decades by anemic growth and no sign of inflation, the Bank of Japan kept rates at zero until last March, when it decided to raise them for the first time in 17 years, to a meager 0.1%, far from the range between 5.25% and 5.5% at which the price of money is in the United States. The environment was conducive to a weak yen against the dollar, which especially favors the powerful export companies listed in Japan, in an economy that was beginning to emerge from economic stagnation.
The Japanese market has also benefited in recent times from the measures adopted by the authorities to boost the stock market, with improvements in corporate governance and capital allocation in order to boost share prices, including buyback programmes. At a meeting held last October with the top brass of investment giants BlackRock, KKR, Blackstone, GIC and Norges Bank, Japanese Prime Minister Fumio Kishida stated emphatically: “I am convinced that people, both inside and outside the country, have perceived Japan’s determination to transform itself into an international financial centre. We will not hesitate to implement new reforms to pave the way for a new Japan. We ask you to invest again in Japan’s future.”
The Japanese market had already dazzled investment icons such as BlackRock and Warren Buffett. The world’s largest asset manager acknowledged in mid-July that the Japanese stock market was its main bet. BlackRock justified its decision by saying that “Japan’s stable macroeconomic outlook – with moderate inflation fueling rising wages and companies’ ability to set prices – has reinforced our optimistic outlook for equity returns over strategic horizons of five years or more.” But it did not expect that the Bank of Japan would raise rates again on July 31, to 0.25%. This move accelerated the appreciation of the yen, which in the last two weeks has gone from 154 units per dollar to 146.9. Bad news for Japanese listed companies and for investors who had chosen to borrow in yen to invest in Japan or Wall Street.
For Akira Fuse, stock manager at MFS Investment Management, “Japanese equity markets remain very volatile and volatility can be expected to continue in the coming days and months, especially given the forecast of a rate cut by the Federal Reserve in September.” At Natixis IM Solutions, its head of strategy Mabrouk Chetouane acknowledges that the markets have overreacted and adds that there is little rational justification for the worst performance of the Japanese stock markets in 37 years other than panic. “Japanese equity markets have already erased part of their losses and we expect this recovery to continue as volatility normalises,” he says. Meanwhile, the manager has opted for a more neutral position on the global stock market in the face of the economic slowdown. “Our overexposure to the US, European and Japanese equity markets will be progressively reduced until the economic cycle shows greater signs of improvement,” he explains.
The caution that has been imposed on Japanese equities these days does not, however, overshadow a more favourable outlook for the medium and long term. “In the medium term, our confidence in the Japanese stock market is intact and the Japanese capital markets are intrinsically safer and offer greater visibility compared to China,” adds Chetouane. At MFS IM, despite the volatility they expect in the short term for the Japanese stock market and their forecast of a stronger yen, they are confident that “our attention to long-term company fundamentals, the sustainability of earnings and low valuations will allow us to generate good returns for the client portfolio throughout an entire market cycle.”
Swiss firm Lazard is also optimistic, arguing that the current moment is an opportunity to review the strategic weight of Japanese equities in its portfolio. In their opinion, two key themes will continue to develop in the medium and long term: improved corporate governance, which drives greater capital efficiency and higher returns for shareholders, and the shift from deflation to inflation, which is gradually transforming consumer behaviour. “Although price-earnings valuations have returned to their 10-year average, the enterprise value/ebidta ratio remains significantly lower than in other developed markets, which, in our view, is a better indication of the potential for improving capital efficiency,” they conclude.
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