Not even an interest-rate hike for the first time since 2007 has slowed the record-breaking surge in Japanese shares.

Signs that deflation has ended are driving investors to bet ever more on Japan’s economic growth, while a weakening yen continues to boost exporters like Toyota Motor and Canon. Morgan Stanley has maintained its target for the broad Topix equity gauge to rise to 3,100 in its bullish scenario, just 10 per cent away from Friday’s ( Mar 22) close.

In normal times, rate increases by central banks should hurt most shares as they tend to push up borrowing costs. But these aren’t ordinary days in Asia’s second-biggest economy, with the return of inflation prompting the Bank of Japan to abandon its arsenal of radical monetary easing steps including the world’s last negative-rates regime. An official push on companies to improve shareholder returns has attracted a slew of funds from overseas, while the Nikkei 225 Stock Average’s jump above 40,000 to all-time highs has led to Japanese individuals betting on more gains.

Japan was the favorite in Asia Pacific for investors in the lead-up to the BOJ meeting, with a net 67 per cent expecting its economy to strengthen in the next 12 months, according to a Bank of America fund manager survey. They were polled in the week before the policy-setting gathering, when traders were pricing in a rate hike. Morgan Stanley still has an overweight stance on Japanese equities versus Asia and emerging markets after the BOJ’s March 19 move, and its analysts say that investors should focus on sectors highly linked to the end of deflation such as food and real estate. 

“We could potentially see the Nikkei hitting 45,000 before the end of the year,” said Shigeharu Shiraishi, representative director at Know’s i-land Asset Management, who has overseen Japanese equities for more than 50 years. “It’s not often that both overseas investors and domestic individuals are positive about the Japanese market.”

Foreign investors including Warren Buffett have helped push up Japanese stocks to record highs. They’ve bought shares on a net basis in nine out of 12 weeks from the start of the year, according to Tokyo Stock Exchange data. Individual investors have also been coming back to the booming market, buying the most in the latest five-day period since the final week of September 2023.

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The question now is when Japan’s central bank may take further policy action. Of 47 polled analysts, 29 expect the BOJ to increase rates again by October, according to a Bloomberg survey of economists.

If expectations strengthen for further interest rate hikes, investors may try to buy companies more reliant on domestic demand that are less affected by rate moves, while selling firms more dependent on external demand and sensitive to rate changes, JPMorgan Securities Japan analysts including Masanari Takada wrote in a note. 

Evarich Asset Management is considering boosting its stakes in the nation’s lenders and construction companies after the BOJ ended negative rates. Its Japan-focused 19 billion yen (S$169.3 million) Nippon Growth Fund, which has beaten 98 per cent of its peers this year, holds builders such as Obayashi and Kajima.

Purchasing Power 

“If Japanese companies increase wages, people’s purchasing power will increase, and that will greatly benefit domestic demand companies,” said Naoki Fujiwara, chief fund manager at Shinkin Asset Management, who sees a turnaround in the sector during the summer. 

Not everyone’s convinced that demand in Japan is headed much higher. The BOJ is still buying bonds and officials have pledged to keep interest rates low. Expectations that the central bank’s future rate hikes will be gradual and limited are keeping Japan’s bond yield gap with the US wide, and helping weaken the yen against the dollar despite the BOJ decision.

“Considering Japan’s national character, just because wages go up a little, does that mean individuals will go buy more? I don’t think so,” said Tomohiro Okawa, chief executive officer of PS Oskar Group LLC, an investment advisory firm. Raising wages too much while domestic demand isn’t very strong will eventually put pressure on corporate earnings, he said.

Still, while tighter monetary policy could damp domestic demand and lessen inflationary pressure, it will likely have only limited impact in Japan, Fitch Ratings said in a report. That’s because companies and households have solid balance sheets, and the government has strong financing flexibility, the rating firm said. BLOOMBERG