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Japanese stocks have a way of turning people into professional cynics. So it is perhaps fitting that after months of gains, some investors are starting to wonder whether this famously fickle market has gone too far.
There is no small irony in getting to this point. It has taken more than 30 years for the Topix and Nikkei indices to meaningfully recover from the market’s spectacular crash, and they are still below the 1990 highs. A series of false dawns have stung a lot of money managers and left them reluctant to engage for years.
One fund manager said his decades of efforts trying to eke returns out of this market represented a “misspent youth”. Fast cars and dingy bars might have been more fun.
But everything has come together this year, despite the very clear consensus that 2023 would be similarly drab. The Topix and Nikkei 225 are both up more than 20 per cent so far this year. That drops in to single figures in dollar terms but this remains a breakout year.
Monetary policy has certainly helped. After long struggling to escape from the painful era of rock-bottom low inflation, the Bank of Japan is not in a hurry to stomp on the first bout of substantive growth in prices for years. It has left its benchmark rate below zero and maintained a cap on bond yields, in blunt contrast to the rest of the developed world. The rise in inflation has forged a real shift in the mindset of corporate Japan. The central bank’s insistence on making sure that inflation sticks has also hammered the yen, which boosts exporters, although the true extent of its importance to stocks is debated.
The main support, though, has come from the stronger focus at a government level on corporate reform — and on fostering healthier capital markets with broader retail participation.
Big global investors have risen to the bait. The biggest of them all, BlackRock, said this month it would raise its allocation to Japan, putting a larger slice of resources in to the country’s stocks than benchmarks would suggest. The global market environment of high interest rates, sluggish economic activity and persistent inflation are bad news for many key equity markets, the BlackRock Investment Institute said. But Japan is different. “We turn even more positive on Japanese equities, going overweight due to strong earnings, share buy backs and other shareholder-friendly corporate reforms,” it said.
UBS Wealth Management also said this month that equity investment flows in to Japan had surpassed those in to China for the first time since 2017. “But we think Japan is still under-owned and under-appreciated by both global and domestic investors compared to history,” chief investment officer Mark Haefele wrote.
“This year’s rally in Japanese equities is being driven by a developing fundamental investment case, which we expect will continue into next year and beyond, making the market a convincing long-term destination in a low-growth developed world.” Respondents to Bank of America’s regular fund manager survey are now running their biggest overweight position on Japan since 2018.
So what’s not to like? Zuhair Khan at Swiss private bank Union Bancaire Privée, who runs a fund of Japanese stocks, is one of many veterans delighted with the attention — and with prospective clients’ willingness to take his calls after years in the wilderness. But he has his doubts.
“I love all the interest, don’t get me wrong,” he says. “It’s better than when people ignored Japan. But a lot of people are flooding in. It’s a bit scary.”
Khan’s fund takes positive bets on Japanese companies that are making progress on corporate governance, and negative bets, or shorts, on those that are not. He believes that positive corporate reform and the greater focus on profitability are real. But his caution lies in a sense that the power of the rally this year has bumped up the valuations of many companies that are just paying lip service to this agenda.
“All my governance research shows one-third of companies remain bad governance companies with the old zombie image,” he says. “They are resisting change. But a lot of those companies have gone up just as much as the others. When we look at the market today, there’s a lot of opportunities to make money from the short side.”
Bank of America’s survey also shows that investors rank Japanese stocks as the world’s third most crowded bet — far behind US technology stocks and the negative bet on China, but still towards the top of the pile.
Peter Tasker, one of the best-known old hands in this market, having co-founded the Arcus Investment firm in 1998, agreed that the rising tide of flows in to the market this year might have created “a bit” of a bubbly mood. But, he says, “it’s different from the US. It’s not on the same scale.” Arcus believes the country now offers an opportunity to investors that has been “25 years in the making”.
A horrible global economic slowdown is probably the biggest risk to Japanese stocks now, investors say, just as it would be to other big markets. Any additional gnawing doubts over excessive enthusiasm are a compliment, a sign that investors are starting to view this market through the same lens as everything else.
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