Flows into Japanese equities highest in 20 years; analysts say market still has room to run

INVESTOR interest in Japanese equities is at its highest in several decades, thanks to improving economic fundamentals. In spite of already high valuations, many analysts continue to see upside for the country’s stock market.

Foreigners put a net US$31.8 billion into Japanese equities in the year to Jun 2.

This is the highest – on a cumulative year-to-date basis – since 2013, when Japan’s then prime minister Shinzo Abe launched his “Abenomics” economic programme, NatWest Markets emerging markets strategist Galvin Chia said.

The Nikkei 225, Japan’s benchmark index, hit a 33-year high of 33,018.65 points on Jun 13.

“It’s not easy to pinpoint where the funds are coming from exactly, but one flow dynamic at play is a likely rotation out of China into other Asian economies – Japan included,” said Chia.

“In May, foreign investors pulled around US$1.4 billion from Chinese equities; Japan aside, this has also coincided with a rise in allocations to Taiwan (US$5.2 billion), India (US$5 billion) and South Korea (US$3.1 billion).”

Morningstar data shows that Japan-focused equity funds domiciled in Europe, Asia and Africa started recorded net inflows of US$647.1 million in April this year, and US$3.2 billion in May. US-domiciled Japan equity funds recorded net inflows of US$704.3 million and US$1.2 billion, respectively, in April and May.

Net flows into these funds totalled US$2.7 billion over the first five months of this year.

Vikas Pershad, portfolio manager for M&G Investments’ Asian equities, expects Japanese equities to be re-rated upwards thanks to a “high single-digit earnings increase, and rising dividends and shareholder buybacks”.

“Japanese companies, spanning semiconductor manufacturing, renewable energy, automobiles and more, possess global relevance within multiple supply chains. The opportunities within the Japanese market are vast,” he said.

Indeed, Bank of Singapore (BOS) has upgraded its tactical asset allocation to Japanese equities to “overweight” from “neutral”.

Eli Lee, head of investment strategy at BOS, said the outlook for Japanese equities is favourable given a combination of resilient economic fundamentals, an accommodative monetary policy stance, a relatively weak currency, and positive corporate governance reforms.

“In particular, the drive towards corporate governance reforms could benefit shareholders and could help improve the valuation of the Japanese equity market, which tends to exhibit lower price-to-book and return-on-equity ratios compared with US and European equity markets,” Lee told The Business Times.

BOS is bullish on Japan’s domestic consumer discretionary segments, such as retailing and travel, on the back of a rebound in tourism. It also favours consumer staples, which would benefit from rising wages and falling global raw material costs.

The Japanese banks, too, will benefit from healthy loan growth as the economic recovery gets under way. There is also potential for net interest margin expansion if the Bank of Japan (BOJ), the country’s central bank, ends its yield curve control programme as some observers expect.

Yield curve control refers to the BOJ’s policy to keep yields within a specified range by buying bonds.

Bank of America expects corporate buyback momentum to continue this year, helping to support the rally; and online brokerage platform FSMOne.com said currency tailwinds could also help the market.

At the same time, Lorraine Tan, Morningstar’s director of Asia equity research, noted that the recent run-up leaves the Japanese companies in Morningstar’s coverage list less attractive compared with the broader Greater China market.

Among the counters that it tracks, Tan said, those exposed to the economic cycle still have value.

“We think these names are still lagging on concerns over slowing orders, as global growth lags and some industries are still absorbing excess supply,” she added. “While we don’t expect revenue growth to pick up much this financial year, we are buyers, as we factor in the macro conditions to start improving in early 2024.”

Stocks in this space include electronics and materials company Taiyo Yuden, engineering company Nabtesco and speed-reducer producer Harmonic Drive Systems.