It took 33 years—longer than almost all fund managers have been in the business, and longer than some of them have even been alive. But in the end, Japanese stocks returned to normal.
The question, of course, is whether it will disappoint hapless international investors yet again. In this regard, a key point to watch is the Japanese yen.
The country’s Topix stock index continued its slow but steady rise this week and hit its highest point since August 1990. It’s still nowhere near the dizzying heights it reached during the epic Japanese asset bubble of the late 1980s — there’s a cool 25% or so left before the market returns to that peak.
However, the market in the region has not risen since then turtle power Standing at the top of the UK pop charts. (If that day hasn’t had you humming “Teenage Mutant Ninja Turtles” to yourself, you must have been shielded from the pandemic by virtue of good taste, geographic distance, or youth.)
Japan’s index has been one of the world’s best-performing national benchmarks this year, with the Topix up nearly 14 percent and the Nikkei 225 up 18 percent. That was higher than the near 10% gain in the US S&P 500 and Europe’s Stoxx 600 was up 10%, but France and Germany were still able to outpace that, with gains of around 16% and 17% respectively.
Providing additional durability to the rally, it stems from a combination of sources, including accelerated reforms to corporate governance and a determination to clean up puzzling corporate cross-holdings, and a bunch of “nos.” Of course, Japan is economically sensitive to a post-lockdown China, but it’s not China, so it won’t be under the same geopolitical or regulatory shadow.
Nor is it the US, which is dominated to an astounding degree by a group of top-heavy tech stocks with unusually high valuations. Fun fact: Apple is now worth more than the entire Russell 2000 index of small US companies. Some investors were shocked by the concentration and attracted by Japan’s relatively low valuations.
That’s good news for long-suffering Japanese market pundits who have been waiting for years for a comeback. Yes, the S&P 500 gained about 1000% during the Topix eventual return to 1990 levels. But the excitement among many investors is understandable, with some daring to say “this time is different”.
Eddie Cheng of London-based U.S. asset manager Allspring Global Investments backed the sharp rise in Japanese stocks. He likes the country’s still-cheap valuations and its low stock index weightings for sectors that have recently struggled globally, notably banks.
The Topix trades at 16 times its trailing 12-month earnings compared with 20 times for the S&P 500 and just under 18 times for the MSCI World Index.
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But in the medium term, he described himself as “more cautious”. For him, the key reason why Japanese stocks have performed well recently is the huge gap between monetary policy in Japan and almost everywhere else.
Over the past year or so, the Fed, the Bank of England and the European Central Bank have all launched historically aggressive rate hikes, while the Bank of Japan has remained calm and isolated, keeping rates at rock-bottom levels and buying government bonds to keep a tight rein on output.
Among other effects, this has pushed the yen to its lowest level in two decades. The dollar has retreated from a peak above 150 yen in late 2022, but remains around 138 yen. That makes Japan a better deal for overseas investors.
The danger is that the spread could narrow if inflation in Japan proves to be stronger than the BoJ expects, and if a U.S. recession forces the Fed to cut rates. These are big assumptions, but also plausible results. If they materialize, the mainstay of yen weakness, which has played an important role in boosting Japanese stocks, could collapse quickly. The yen is also a typical safe-haven currency, so the tail risk of a US debt default could easily ignite it.
Investors also point to another potential drag: What if corporate governance reforms fall victim to their own success? Japanese authorities could easily get what he calls “heebeejeebies” – or outbreaks of alarm – if big foreign firms take advantage of a weak currency and improvements in Japanese corporate governance to snap up Japanese companies, according to a fund manager. cheap. “That’s the biggest fear, it’s too fast,” he said.
All of this may reflect an overly cautious fund manager looking for reasons to worry. For example, even if the Bank of Japan does tighten monetary policy, it will almost certainly be a long and slow process rather than a sudden shock that sends the yen surging. But, after so many false dawns, it was perhaps inevitable to look for problems.
katie.martin@ft.com