Even as Japan’s stock market hits a 33-year high, interest in it has continued growing instead of waning as investors globally forget about the country’s “lost decades”. Morgan Stanley is the “most bullish” on Japan among the major equities markets. “We believe Japan value stocks with high-quality balance sheets could benefit and turn into a prolonged outperformance,” gushes the team in their June 4 report, where they raised their June 2024 target for the Tokyo Stock Price Index (Topix) by 18% to 2,400 points, suggesting a further upside of 13%.
“Our long-standing theme of ROE improvement and productivity and innovation resurgence increasingly resonates with investors in the ongoing multipolar world era,” says the US bank, adding that Japan’s trailing ROE now stands at 9.5% and has been moving towards global peers since the “Abenomics” suite of reforms kicked off under the former prime minister in 2013, leading to a “surprisingly strong” EPS CAGR of 11% over this past decade.
Japanese stocks have enjoyed re-rating, from trading at below 0.8 times P/B at the launch of Abenomics in early 2013 to 1.3 times currently. Morgan Stanley sees a further improvement and continues to target a mid-cycle ROE of 11% to 12% for 2025 and further valuation re-rating. “At the stock level, we continue to focus on capital management and self-help stories alongside productivity and innovation leaders.”
Bank of Singapore is similarly upbeat. “In contrast to broadly declining growth across developed markets, we expect Japan’s economic outlook to stay resilient, which is corroborated by recent encouraging data on economic activity, inflation and wages,” write strategists Eli Lee, Joseph Ng and Neo Bee Leng in their June 1 note.
They point out that unlike in the US and Europe, Japan did not conduct outsized pandemic-related spending. Furthermore, Japan is less dependent on natural gas imports than Europe and is not hit by the war between Russia and Ukraine. “As such, the interplay of economic growth, labour markets, and inflation in Japan point to lower risks of an overheating economy or runaway inflation than in the US and Europe,” the strategists write.
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The country’s central bank, the Bank of Japan, does not face the same urgency as its US and European counterparts to hike rates to curb inflation. Furthermore, Japan’s policymakers are also reluctant to tighten prematurely or over-tighten after previous long periods of too-low inflation and growth. “As a result, broadly easy monetary policy and a weak yen are set to remain supportive of Japan’s economic activity and asset prices,” the strategists add.
In addition, Japan is seeing a renewed push for corporate governance reforms, benefitting equity valuations. At the same time, Japanese companies sit on high cash levels and have historically lagged developed market peers in returning capital to shareholders, resulting in lower P/B valuations.
“We have seen an increase in corporate share buybacks, and continued momentum in shareholder-friendly governance will help attract global investors seeking value and diversification, especially given their relative under-allocation to Japan equities,” the strategists point out.
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Credit: Bank of Singapore
David Chao of Invesco believes that the recent rally in Japan was because global investors are sitting on excess piles of cash waiting to deploy and Japan reopened from the pandemic curbs much later than other developed economies; domestic spending is only at its nascent stage.
That aside, thanks to a weaker yen relative to the US dollar, corporate earnings of Japanese firms — many of which export heavily and have overseas subsidiaries — are seen to pick up, says Chao, global market strategist, Asia Pacific (ex-Japan) at the firm. “Foreign equity investors can still benefit from the yen’s continued weakness as corporate earnings are boosted by a weaker yen and price performance improves if the yen appreciates.”
Chao notes that despite the demographic decline in Japan over the past few decades, the economy has grown through efficiency and productivity gains. Healthy trade growth and investments made overseas helped as well.
He also observes that many Japanese companies are trading below book, and sustained valuation expansion could bring back domestic and foreign investors. “I think it’s possible that Japanese equities could outperform other developed markets this year.”
While upbeat, Chao is careful not to get too carried away. “I am cautiously optimistic on Japanese equities: The asset class has seen many false dawns, but recent global macro and domestic demand dynamics have been a promising start.
