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Japan on the right track to recovery

Samantha Chiew
Samantha Chiew • 13 min read
Japan on the right track to recovery
a Shinkansen bullet train at Tokyo Station. Photo: Bloomberg
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Japan’s equity market has rebounded to previous record levels, with corporate reforms playing a pivotal role in this resurgence


Japan may have relinquished its position as the world’s second-largest economy to China but its appeal to international investors remains unwavering. The Nikkei 225 index has finally surpassed the previous peak attained over 30 years ago, a testament to Japan’s enduring allure as an investing destination.

“Japan is at an investment inflection point that contrasts with what we have seen over the past three decades,” says Yue Bamba, BlackRock’s head of active investments for Japan, in an interview with The Edge Singapore.

“The investment opportunities in Japan’s mature economy are starting to gain significant traction due to pivotal shifts across the macroeconomic landscape, government initiatives and company-specific competitive advantages — particularly those related to the ability to provide innovative technological solutions to the world’s ageing population and problems related to labour shortage.”

Bamba anticipates strong economic growth in Japan, driven by factors such as moderate inflation, government support, corporate reforms, and competitive advantages in trending sectors.

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In addition, the Bank of Japan (BoJ) ended the world’s last negative rate regime by raising rates for the first time in 17 years in a closely watched decision on March 16.

The central bank raised key interest rates from –0.1% to 0%–1% amid rising wages and consumer prices. Economists widely anticipated this hike after governor Kazuo Ueda, a Professor Emeritus at the University of Tokyo specialising in economics, took office in April 2023.

Since 2016, Japan has been in the negative interest rate territory when the BoJ cut rates to below zero in an attempt to stimulate the economy. This meant people had to pay banks a fee to deposit their money in the bank, which encouraged them to spend the money to stimulate the economy and deterred them from saving.

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The BoJ also said it was abandoning yield curve control (YCC), another policy implemented in 2016. This policy involved the Japanese government purchasing bonds to control interest rates but it has been criticised for distorting markets by keeping long-term interest rates from rising.

In a statement announcing the decision, the BoJ said it will keep buying “broadly the same amount” of government bonds as before and ramp up purchases in case yields rise rapidly.


Banks first to benefit

Major banks, including Mitsubishi UFJ Financial Group and other top lenders, have about JPY106.7 trillion ($956 billion) in reserves that are currently paying no interest, according to BoJ data. They have another JPY79.4 trillion on deposit that is earning 0.1%.

In announcing the end of its negative interest rate policy on March 19, the BoJ said it would pay 0.1% interest to current account balances, excluding required reserves. The new interest rate took effect on March 21. If that is applied to current reserves, major banks will earn additional interest of about JPY100 billion annually, according to Bloomberg calculations.

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Some banks have already announced plans to raise rates for retail depositors. Following the rate hike, Mizuho Financial Group’s CEO Masahiro Kihara said Japan’s third-largest lender will raise the interest it pays savers to spur deposits as a funding source.

While banks have the opportunity to earn interest, they are likely to deploy the cash to where there are better returns. Hideyasu Ban, a senior analyst at Bloomberg Intelligence, says they will likely shift their current account balances at the BoJ to government bonds as yields rise.

“Banks with higher weights in domestic interest-earnings assets or have cash sitting at the BoJ will have higher earnings sensitivity to domestic rate rises,” says Ban.

From here, investors can expect further rate increases to be made gradually, which builds the case for Japanese equities to advance, at least over the medium term, says Bloomberg.

The announcement should also leave some room open for the central bank to reduce its bond purchases, although the commitment to maintain its buying patterns should mitigate the risk of a surge in yields.

From boom to bust to recovery

Japan’s multi-decade economic boom that started in 1945 reached the zenith of prosperity in 1989 before the bubble burst abruptly. The country’s position as an economic powerhouse then began to wane, plunging into a period of stagnation famously termed the “Lost Decades”.

After years of sluggish recovery, Japan’s equity market has finally surged to previous record levels. Corporate reforms have been instrumental in this resurgence: Japanese companies now prioritise shareholder value by increasing stock buybacks and dividends. Consequently, Japan Inc has become more appealing to investors. This trend is further propelled by various factors, notably currency depreciation and optimistic investment prospects.

The Japanese yen is at its lowest level in the past three decades, which is beneficial to the country’s tourism industry. In addition, according to Janet Liu, vice-president of investment advisory at StashAway, a weaker yen also means that Japanese exports become more affordable and competitive in the global market. “As people choose to buy more Japanese goods, that boosts revenue for Japanese companies — and profits,” says Liu.

Mabrouk Chetouane, head of global market strategy at Natixis Investment Managers Solutions, notes that despite the tremendous rally in Japanese stock markets over the past months, the Nikkei and Topix indices seem unstoppable, even matching the Magnificent Seven stocks in the US and Granola stocks in Europe in US dollar terms and even surpassing them in local currency terms.

Year to date, the Nikkei has risen by 19.9% in local currency while the Topix has gained just 14.5%. “Such a rise could prompt investors to take profits. In our case, we have kept our over-exposure unchanged convinced that Japanese stocks still have room for progress,” says Chetouane. This conviction is underpinned by three key arguments.

Firstly, unlike in the US, the Japanese stock market’s rise is not concentrated in one or two key sectors. The year-to-date performance of Japan’s leading indices is more balanced and driven by two different and very diversified sectors: financial, information and technology, and discretionary consumer (which includes the automotive sector according to the MSCI classification).

As a result, the rise in stock prices is more evenly distributed and therefore more robust compared to its peers. This gives the Japanese stock market a better outlook since the absence of biases — as is the case in the US with the technology sector or in Europe with cyclical stocks — increases the probability of taking advantage of all the factors that could boost the performance, says Chetouane.

Secondly, the return of inflation is also a strong argument for remaining exposed to Japanese equities. Japan appears to have moved away from the deflationary environment that has plagued its economy over the past few decades. Inflation surveys point to continued inflationary pressures in the short term.

Therefore, Japanese companies are now better equipped to protect their margins and are seeing their earnings forecasts rise significantly in line with what investors are looking for — growth.

Thirdly, the recent rate hike could eventually lead to currency appreciation and consequently dampen investor appetite for equities. However, the normalisation of monetary policy reflects a solid economic outlook.

“The BoJ should be seen as an ally as it will continue to support this positive momentum, which is why we do not see the BoJ tightening monetary policy beyond this increase of 10 bps,” says Chetouane.

After several decades, foreign investors are finally finding confidence in Japanese equities again. This is further supported by the massive influx of foreign capital into the Japanese capital markets as investors see Japanese companies as a source of steady revenue growth over the coming year despite their valuation levels.

“Investors are willing to pay for steady, high-quality growth. This is what Japanese equities now offer,” says Chetouane.

Sectors to watch

Blackrock’s Bamba believes medical technology and semiconductors are two sectors that bear watching in Japan.

Bamba highlights a Japanese medical equipment and service provider as an exemplary case of leveraging advanced technology to address labour shortages. This company boasts the largest market share in ICU bed monitors and has made significant advancements in patient monitoring systems through innovative technology.

Beginning next year, the Japanese government will enforce limits on overtime hours for medical professionals, aiming to enhance the work-life balance for healthcare workers. In an ageing society grappling with severe labour shortages, maximising the efficiency of doctors and nurses is imperative. Bamba says the company meets the demand for efficiency with its groundbreaking patient monitoring systems that enable medical staff to remotely access patients’ vital data, whether displayed on screens outside hospital rooms or via mobile devices.

To add to Japan’s competitive advantage in technology, Bamba says foreign direct investment in areas such as semiconductor manufacturing has surged. Japan’s political stability and close ties to the US and Europe are also of great value to global corporations which are pressed to shift supply chains amid geopolitical tensions, resulting in benefits for Japanese corporations in adjacent areas.

Japanese companies hold a vital position in the global semiconductor supply chain. For instance, many may not recognise the term “photo­resists”, yet without this crucial component, devices like computers, smartphones and electronic notepads would display blank screens. While none of the top five semiconductor manufacturers are based in Japan, they are all well aware of their counterparts in the photoresist industry. Based on company filings and data from Japan’s Ministry of Economy, Trade and Industry, Japanese companies dominate this critical tech market, boasting nearly 80% of the global market share as of September 2023.

Isaac Lim, chief market strategist at Moomoo Financial Singapore, shares a similar view and identifies growth potential in the semiconductor and tech sectors fuelled by the recent surge in interest in AI. He believes that this trend will value add to any investors looking for some exposure. “Furthermore, traditional sectors such as financials and consumer discretionary are good sectors to invest into,” he says.

“While single Japanese stocks are not easily accessible for the retail investor, one way to gain broad exposure to the Japanese equities market would be a recently Singapore-listed ETF, the Lion-Nomura Japan Active ETF (Powered by AI). Alternatively, there is WisdomTree Japan Hedged Equity ETF that focuses on dividend-paying stocks,” Lim adds.

He also believes that the tourism sector in Japan is poised for continual growth unless there are new restrictions imposed by the Japanese government on tourist arrivals.

According to Japan’s Tourism Board (JTB), for the year ended 2023, there was a y-o-y increase of 99.5% of overseas visitors. Lim sees Japan as a destination as a country with something for a tourist in any season. From sightseeing to shopping experiences and even winter activities, Japan is easily one of the top spots for a holiday.

Statistics from travel platform Skyscanner show that Singapore is ranked sixth on the list of top-ranking nationals who visited Japan in 2023, with a surge of search volumes in January, March and November, possibly to enjoy the winter and spring seasons.

Furthermore, the recent announcement of opening an integrated resort (IR) by 2029 in Osaka would add to an already long list of activities that Japan will be able to provide. Lim shares that the cost to build the Osaka IR is slightly more than the costs of Singapore’s Resort World Sentosa and Marina Bay Sands combined. Analysts estimate that the Osaka IR, when completed, would generate about JPY520 billion in revenue. This would also strongly contribute to the hospitality industry in Japan.

What about the fundamentals?

Nevertheless, Moomoo’s Lim remains cautious about the fundamentals of Japan’s economy. While the latest government data showed that Japan’s economy avoided a technical recession, the GDP growth forecast was lower than expected, with domestic demand remaining lacklustre.

Japan’s economy slipped into a recession after shrinking for a second quarter due to anaemic domestic demand, before the BoJ announced the rate hike. GDP contracted at an annualised pace of 0.4% in 4Q2023, following a revised 3.3% retreat in 3Q2023, according to data from the Japan Cabinet Office.

The February report showed that households and businesses cut spending for a third straight quarter as Japan’s economy slipped to the fourth-largest in the world in dollar terms last year. Germany now has the world’s third-largest economy.

In the longer term, Lim expects Japan’s economy to grow and recommends investors allocate some of their resources to the Japanese markets for exposure, if not for diversification of their portfolios.

Blackrock’s Bamba, however, believes that other changes are afoot, driven by regulations and the focus by authorities on reinvigorating an economy facing steep demographic challenges, and this can brighten the backdrop for Japanese equities.

Bamba says: “We preferred Japan to other developed market equities. Now, we are turning more positive, going overweight due to strong earnings, share buybacks and other shareholder-friendly corporate reforms. A confluence of developments has thrust Japan into the spotlight — a major turn from what we’ve seen in Japan investment opportunities in the past decades that have the potential to change the global investment landscape for the coming years.”

Meanwhile, Ben Powell, chief Asia Pacific investment strategist of BlackRock, sees the macroeconomic backdrop in Japan remaining conducive to risk. The BlackRock Investment Institute is overweight on Japanese equities despite their recent healthy gains and remains underweight on Japanese government bonds.

“We see the outlook for equities buoyed by healthy earnings momentum, accelerating shareholder-friendly reforms unfolding across Japan Inc and valuation support from negative real interest rates. The sun is not setting on Japanese equities, in our view; it is merely rising on a new horizon,” says Powell.

Going forward, David Chao, global market strategist, Asia Pacific (ex-Japan) at Invesco, does not anticipate additional rate hikes from the BoJ before the end of the year. Possible changes to the policy rate will likely be based on price stability projections.

“For now, the BoJ has maintained its core CPI projection of around 2% for the upcoming fiscal year. Unlike the Fed’s dot plot, the BoJ does not give out an overt future policy rate path. Instead, more nuanced guidance can be expected — it is good to read through the comments surrounding the bank’s inflation targeting,” says Chao.

While Japanese equities have experienced a strong rally in the past year, Chao notes that their valuations are still attractive relative to other major indices. In addition, the dividend yield of Japanese equities is higher than that of other major indices.

“A powerful catalyst for Japanese equities to climb higher could be the new Nisa (Nippon individual savings account), a tax-exempt investment savings plan introduced in January. Cash deposits comprise 52.5% of households’ financial assets in Japan, 12.5% in the US and 35.5% in the eurozone. The Nisa could be the catalyst to move some Japanese household cash to equities,” adds Chao. 


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