MC Explains | Why Japan, Eurozone markets are rising even as recession threat looms

"There is often a mismatch in the direct representation of various sectors in the equity market. The disparity between the real economy's composition and that of listed companies can lead to skewed perceptions of economic health in the medium to short run," Hajra told Moneycontrol.

What is happening in Japan?

The benchmark Nikkei index is at its highest level in over 34 years. Seen another way, the market just managed to surpass its previous peak seen in December 1989. This is despite the economy logging two consecutive quarters of decline.

What could possibly explain this trend?

"Over the last 34 years, Japan's GDP in dollar terms increased from $3.1 to $4.2 trillion. This indicates that the equity market is aligning with the broader economic growth, and playing catch-up, rather than leading the way," Hajra said.

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What's fuelling the exuberance in Japanese markets?

Investors are optimistic as corporate earnings for the last quarter of 2023 were 45 percent higher year-on-year, according to Goldman Sachs analysts. Economists are also cautiously optimistic that Japan might be able to reverse long-running deflation, and become more of a normal economy again. Rising wages amid a tighter labour market by companies, including Toyota, Nintendo, and Uniqlo owner Fast Retailing have boosted the confidence in the economy.

Is there any other factor?

Another reason behind the surge in Japanese stocks is the outflow from China as the Chinese economy struggles. Foreign investors have begun pulling money out and putting into other destinations, including India and Japan. Also, Japan is among the beneficiaries of the ‘China plus one’ trend as the West looks to reduce dependence on China.

Why are European markets rising, despite several nations on brink of recession?

The European economy faces headwinds such as a weak industrial base, recession in Germany, and the looming presence of Donald Trump and his talk of tariffs. Despite this, the pan-European Stoxx 600 recently surged to new highs. This was mainly due to the fact that many of the largest stocks in the index are globally facing, and benefit from broader trends such as healthcare spending and drug innovation.

Also, the eurozone is stabilising, avoiding a mild recession, buoyed by strong earnings from major companies like Nestle and Rolls-Royce, and improved business activity in February, especially in the services sector. Despite ongoing inflation concerns in the UK, global markets are influenced by economic trends in the US.

How is the US positively impacting the European markets?

The global economy often depends on the US to act as the engine of growth, and global financial markets rely heavily on the disproportionately large risk appetite of US investors. This became more evident in 2023 when major economies of Japan and the United Kingdom slipped into recession, Germany narrowly avoided one, and China grappled with obstacles to growth and pockets of high debt, but the soft landing of the US economy managed to impart positivity to other markets.

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According to Rajani Sinha, chief economist at CARE Ratings, the global markets have factored in rate cuts by the US Fed later this year. Interest rate cuts increase the liquidity, boosting investment and asset prices, while lowering transaction costs and encouraging trading. If the US economy recovers quickly, global markets are likely to respond positively.