It has taken 33 years — longer than almost all fund managers have been in the industry and indeed longer than some of them have even been alive. But finally, the Japanese stock market is back in business.
The question of course is whether it is going to lead hapless international investors to disappointment yet again. In this regard, one key thing to watch is the yen.
The country’s Topix stocks index this week kept up its slow and steady ascent, and struck its highest point since August 1990. It is still nowhere close to the dizzying heights it struck in the epic Japanese asset bubble of the late 1980s — there’s a cool 25 per cent or so to go before the market is back to that peak.
Still, the market has not been up in this territory since Turtle Power stood at the top of the UK pop charts. (If that doesn’t have you humming ‘teenage mutant ninja turtles’ to yourself for the day, you must have been shielded from this pop aberration by either good taste, geographical distance, or youth.)
Japanese indices are among the best-performing national benchmarks in the world this year, with a gain of nearly 14 per cent in the Topix and 18 per cent in the Nikkei 225. That towers above the nearly 10 per cent gain in the US S&P 500 and also holds its own among another rare sprightly run in Europe — the Euro Stoxx 600 is up 10 per cent, but France and Germany can still beat that, at around 16 and 17 per cent respectively.
Giving extra durability to the rally, it stems from a range of sources, including an accelerating revamp in corporate governance and a determined effort to clean up puzzling company cross-shareholdings, plus a bunch of “nots”. Japan is economically sensitive to a post-lockdown China, of course, but it is not China, so it does not sit under the same geopolitical or regulatory shadows.
It is also not the US, which is dominated to an alarming degree by a top-heavy clutch of tech stocks with outlandishly high valuations. Fun fact: Apple is now worth more than the entire Russell 2000 index of smaller US companies. Some investors are spooked by this degree of concentration and drawn to Japan’s relatively low valuations.
To the long-suffering Japan market specialists who have been waiting for a comeback for years, this is great news. Yes, the S&P 500 has added around 1000 per cent in the time the Topix has taken to finally claw back up to its 1990 levels. But many investors are understandably excited and some are daring to utter the words “this time is different”.
London-based Eddie Cheng of US asset manager Allspring Global Investments, is on board with the big upswing in Japanese stocks. He likes the still-cheap valuations and the country’s low stock-index weightings to sectors that have been struggling globally of late, particularly banks.
The Topix is trading at an aggregate price that is equivalent to 16 times its earnings over the previous 12 months, compared with 20 times for the S&P 500 index and just under 18 times for the MSCI World Index.
But in the medium term, he describes himself as “much more cautious”. For him, the key reason Japanese stocks have done well of late is the huge gap in monetary policy between Japan and, well, pretty much everywhere else.
The US Federal Reserve, Bank of England and the European Central Bank have all launched historically aggressive interest-rate rising campaigns over the past year or so while the Bank of Japan has stood serene and alone, holding rates nailed to the floor and buying government bonds to keep yields under strict control.
Among other effects, this has pushed the yen to some of its weakest levels in two decades. The dollar has backed down from its peak above Y150 in late 2022, but it still sits at Y138 or so. That makes Japan more of a bargain for overseas investors.
The danger is that differential could shrink if Japanese inflation proves punchier than the BoJ expects and if there is a US recession, forcing the Fed in to rate cuts. These are both big ifs but also both plausible outcomes. If they come to pass, the pillar of yen weakness playing a big role in pumping up Japanese stocks could quickly crumble. The yen also serves as a typical haven currency, so the tail risk of a US debt default could easily fire it up.
Investors also point to another potential drag: what if the corporate governance revamp is a victim of its own success? One fund manager says Japanese authorities could easily get what he called a case of the “heebeejeebies” — or outbreak of alarm — if big foreign companies were to take advantage of the feeble currency and the improving corporate governance in Japan to snap up companies on the cheap. “That’s the biggest fear, that it’s too much too soon,” he said.
All this may reflect excessive caution among fund managers looking for reasons to fret. Even if the BoJ did toughen up on monetary policy, for instance, that would almost certainly be a long slow process rather than a sudden shock that sent the yen soaring. But hunting for problems is perhaps inevitable after so many false dawns.
katie.martin@ft.com
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