We see potential for Japanese equities to continue to exhibit solid growth in the coming quarters. Indeed, Japan has recently gained in popularity especially among overseas investors in recent months. True, technically the market now looks a bit overbought, but investors should profit from potential short-term weaknesses to add to positions.
Indeed, there are quite a few arguments supporting the Japanese equity markets so that we do not consider the recent performance just as another hype.
Firstly, strong momentum indicators underscore the fact that flows could continue for an extended period. Various investor types are re-discovering Nippon, the most prominent being structural value focused ones. Critically, even after the recent rally, valuations are still at a moderate level, both compared to its own history and to other international markets.
Secondly, there are also robust fundamental factors supporting Japan’s growth case: the country has – eventually – managed to move out of its deflationary trap while the Covid crisis removed many “zombie” companies, which over years were a drag on economic productivity. The conclusion is that real GDP growth potential now looks more solid than in the past. Also, Japanese corporates have finally learned to optimise their capital structure, among other things by re-distributing cash to investors via dividends and share buybacks. This can further support valuations, in particular for the large number of companies with price to book ratios below 1. Finally, while Japan might not be perceived as the epicentre of Artificial Intelligence like the US, many Japanese corporates do provide exposure to the second derivative of this development, such as semi-conductor manufacturing. As we expect the AI-boom to persist, Nippon will also indirectly profit.
Thirdly, monetary policy remains supportive for the time being, especially compared to other developed market countries. Even though ZIRP/NIRP has been in place for an extended time, in terms of real rates, monetary conditions have only truly become “easy” relatively recently. Based on comments by the BOJ, we would expect this environment to remain in place for much longer than elsewhere.
Finally, the “global” market remains underweighted Japan, which is underrepresented in many investors’ portfolios. The recent strong performance will force some of them to at least close their underweights – adding to the buying pressure. Furthermore, one should not ignore that the recent geopolitical tensions between China and the US might have incentivised some market participants to look for regional alternatives to China.
So what are the potential risks we have identified Japanese market?
Obviously, as a rather cyclical market, Japan is exposed to a potential slowdown of the global economy. While we expect Chinese growth to continue to be a solid support, a more severe US recession could weaken growth prospects.
Also, the Japanese equity markets has profited from the Japanese Yen weakness. So while the BoJ is on hold for now, a rapid reversal of its policy could lead to a strong appreciation of the currency, which obviously would hamper competitiveness.
Finally, Japan’s financial cycle is already quite advanced. Should it turn in a more pronounced fashion, financial stability risks might ensue and threaten the outperformance of JP equities.
Greg Hirt is global chief investment officer for multi asset at Allianz Global Investors.
