Japan's stock-market mojo rubs off on me

The Nikkei 225’s 50 percent surge over the past year is largely homegrown.

Well I never. Seeing the Nikkei 225 index make a new high, 34 short years later, is a bit of a milestone. The world's second-largest stock market has got its mojo rising at last. After quadrupling over the past decade, and rising 16 percent in 2024 so far, the burning question is whether this is another bubble moment or genuinely part of a proper renaissance? Forgive me for making this personal, but I'm a believer!

Having started as a graduate trader in London at a Japanese bank, I was plunged right into the tail end of the 1980s real estate-driven equity boom. Thankfully, I skipped most of the remorseless unraveling of the Japanese miracle for the next 15 years, putting it down to a surreal first-job experience. Even as recently as 2012, after a decade of working at other Japanese banks, including a spell in Tokyo, the economy there reverted toward deflation, with the stock market again condemned to irrelevance. But once an old Japan hand, it's with you for life, so faith has returned.

There's a different conviction behind this revaluation of Japanese assets. A rich seam of systemic change is waiting to be mined for opportunities, meaning no longer can it be skipped over in favour of Greater China. This time, Japan Inc really wants to scramble out of its hole and take advantage of the weakening position of its dominant Asian rival. Former Premier Shinzo Abe's famous three arrows of reform are belatedly hitting their targets.  Cultural change is happening with more consistent wage rises, less resistance to mergers and acquisitions and a return to steady inflation.

There are, of course, similarities with the US stock market's recent stellar run. Japan's own Seven Samurai, cherry-picked by Goldman Sachs Group Inc, are undoubtedly buoyed by the Nvidia Corp effect. However, the Nikkei 225’s 50 percent surge over the past year is largely homegrown. It's coming from a markedly different valuation — even at 16 times price-to-forward earnings, it's still a bargain compared with the S&P 500 index's more than 20 times — and in a different galaxy to the peak it had reached (70 times) in 1989.

Though there's growing foreign investor participation, it's not a patch yet on the glory years of the early 2000s, and again in 2013, when US and European investors consistently drove the majority of volume. Warren Buffett may have fired the latest starting gun in August 2020 by investing heavily in Japan's unique trading houses, but that was also an undervalued commodity play.

There's plenty of meat left on the bones, and it's not just in equities, but in residential as well as commercial real estate. If ever the US domestic picture falters, Japan is the obvious alternative for fund managers looking for growth, combined with a cheap currency. Trapped value in the country’s wider stock indexes had become an accepted staple, much of it presumed lost in an impenetrable web of cross-shareholdings and massively undervalued corporate property. The Nikkei 225 is really just the tip of the iceberg, as it's dominated by chip-related stocks like Tokyo Electron Ltd, Advantest Corp and SoftBank Group Corp — all of which are up over 40 percent year-to-date.

The much bigger Topix index has 2150 members and is much more representative of real Japan, warts and all. It's still 8.5 percent off its all-time high. It's no slouch nonetheless, gaining 12.5 percent this year, led predominately by the big banks and automakers. Yes, Toyota Motor Corp. is now a growth stock. The once-omnipotent Ministry for Economy, Trade and Industry is also limbering up with big domestic plans to catch up in the microchip race to benefit a wide corporate audience, not just national champions.

This suggests there's depth and longevity as the main Topix index price-to-book valuation is below one and a half times, just a third of the S&P 500’s. Japan Exchange Group Inc. Chief Executive Officer Hiromi Yamaji
deserves plaudits for pushing through major reforms on governance and liquidity. It's a long, rocky road, but domestic resistance is falling away, as the previously unthinkable take-private of Japanese industrial icon Toshiba Corp illustrated last year.

A major catalyst could be when the Bank of Japan raises its negative 0.1 percent interest rate. It’s the only central bank left with negative rates. There’s a massive structural interest-rate carry trade to consider, as many financial institutions borrow in yen to buy higher-performing assets elsewhere. Japan has the highest developed-nation debt-to-gross domestic product ratio of 263 percent, and the largest debt load of nearly $10 trillion. For now, 10-year Japanese government bond yields are well below the BOJ’s 1 percent yield cap. Where the central bank signals, the captive domestic bond market follows. But the BOJ needs to move slowly and predictably to not trigger financial tsunamis.

With a super-weak yen stuck around 150 to the dollar — it’s tough to compete with 5.5 percent US rates —  it suffers from high hydrocarbon import costs. Japan is a resource-poor country, apart from its plentiful water. However, it weathered the pandemic amazingly well, helped by strong compliance. It’s the only country still that really wants to see prices rise to break its deflationary culture.

The BOJ's relatively new governor, Kazuo Ueda, has played a very canny game awaiting the first rate cut from the Federal Reserve. Inflation is back above its once-deemed-fanciful 2 percent target but not yet fully sustainable. Japan's economy slipped into recession in the second half of last year, nominally causing it to lose its prized third spot globally to Germany. In reality, this is just a weak yen to strong dollar statistical anomaly that will revert with alacrity as Japan’s economic future is considerably brighter. As long as the BOJ can keep the balance right, it will tweak rates into positive territory when it suits Japan. It's a decent setup for a sustained recovery.

Nobody likes in-at-the-top investing, but do keep an eye on the Land of the Rising Sun. Make your own mind up by visiting. It’s like no other place.

Marcus Ashworth is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg