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Japan’s stock market roared higher in the first half of 2023, trouncing gains scored by equities in the U.S. and other developed markets, while defying the tightening trend at other global central banks.
In the year’s first half, Japanese stocks returned 24% in the local currency, as measured by the MSCI family of international indexes, while the U.S. equivalent rose 17% in the same stretch “by successfully fighting the Fed,” according to Scott Opsal, director of research and equities at The Leuthold Group.
Earlier: Japan’s stock market is smoking the S&P 500. Is it too late to jump in? (May 20)
Stocks have continued to drift higher in the second half, with Japan’s Nikkei 225
NIK,
gaining 1.2% on Monday, advancing 25.3% on the year, according FactSet. The S&P 500 index
SPX,
ended the session up 18.6% on the year.
With that backdrop, investors will be tuned into Friday’s Bank of Japan meeting for any changes to its monetary policies, while also scouring the horizon for signals about if the year’s strong stock-market rally still has legs.
On the plus side, bullishness around Japanese stocks hasn’t been limited to billionaire investor Warren Buffett, who’s Berkshire Hathaway
BRK.B,
BRK.A,
in June boosted its stake in a handful of Japanese trading companies.
Read: Warren Buffett is buying Japanese stocks. Should you?
While his “stamp of approval” likely helps, investors also have been piling into the four largest Japan-focused exchange-traded funds, which in June grew to a combined $25.5 billion in assets under management, from $18.7 billion at the end of 2022 (see chart).
Investors flock to Japan-focused ETFs
The Leuthold Group
“Investors are notorious for chasing returns, and flows into the four largest Japan-focused ETFs testify that behavior is holding form,” Opsal wrote, in a Monday client note.
It isn’t only about fund flows. Conservatism from a “multidecade hangover,” following “one of the most legendary asset price bubbles in financial history,” could be a third factor to benefit the region’s stocks, according to Opsal.
Focus on BOJ meeting
Investors aren’t likely to forget the 70%-80% losses on Japanese stocks of the 1980s. But its corporations since have kept “large helpings of excess cash and unproductive assets” on their balance sheets, with nearly 50% of Japanese stocks still trading at less than one times book value, according to Opsal’s estimates.
With the Tokyo Stock Exchange directing most companies to develop plans to improve their stock prices, Opsal said the directive could suggest “increased dividends and higher buybacks” to help “draw down excess cash balances, improve balance sheet efficiency, and elevate stock prices.”
He also thinks the yen’s weakness against the U.S. currency
USDJPY,
currently around 140 per dollar, should help Tokyo by boosting Japanese exports and its industries.
Finally, Opsal sees Japan’s modest economic growth and inflation approaching 3.5% as trends that could encourage consumer consumption and business investments, “thereby improving future economic growth prospects.”
Potential pitfalls to a continued upswing in stocks would be Japan’s aging population and high government debt levels, relative to international standards, he said.
The Bank of Japan has been implementing “yield curve control” since 2016, a policy that keeps government bond yields
TMBMKJP-10Y,
low and credit flowing. BOJ Gov. Kazuo Ueda in May said it would start shrinking its balance sheet and end its yield-curve control policy if a 2% inflation looks achievable and sustainable.
The Federal Reserve, European Central Bank and the Bank of England have been jacking up rates to fight inflation.
“The story is different for the Bank of Japan,” Jean Boivin, head of BlackRock’s Investment Institute’s research team, wrote in a Monday client note. “We see the Bank of Japan opting to keep policy loose to sustain inflation.”
Krishna Guha, head of Evercore ISI’s global policy and central bank strategy team, thinks the BOJ will ease back on or abandon yield curve control “at some point in the second half,” before considering raising interest rates.
“Near term, if there is indeed no change to [yield curve control] at the July meeting, we might expect to see renewed dollar strength / yen weakness and some modest downward pressure on yields, though this will also depend on how much confidence Ueda signals in the inflation outlook, including upside risk to the updated BOJ baseline,” Guha’s team said, in a recent client note.
