As the Japan stock market hits new peaks, is it too late for investors to catch the rising sun?

THE Japan stock market has seen a resurgence after several decades of languishing in the doldrums.

The 1990s were described as the “lost decade” for Japan, as the country’s real estate bubble burst and financial markets collapsed.

At that time, corporates chose to pare down their debts rather than borrow to spend or invest.

This resulted in many Japanese companies holding on to their cash instead of reinvesting them to grow their companies, dampening valuations.

However, the Japanese government has embarked on efforts recently to lift corporate governance of its local market.

Among the changes are market restructures imposed by the Tokyo Exchange Group to improve capital efficiency. Measures such as requiring listed companies to comply or explain if they are trading below book value have helped improve the valuations of Japanese companies.

These moves have propelled the Japan stock market to new heights. The Nikkei 225 index hit a 34-year high earlier this year while the more broad-based Tokyo Stock Price Index also reached a new peak in three decades last year.

For investors looking to get in on the action, the question arises as to whether optimism in the Japan stock market has peaked and if it is too late to catch on its growth.

Are changes to Japan’s stock market sustainable? 

Fundamental to the question is whether the latest changes to Japan’s stock market are sustainable.

Past attempts to jump start the Japan economy had petered out.

In the 2010s, former prime minister Shinzo Abe had imposed a “three arrows” economic reform plan – also known as Abenomics – to lift the Japan economy. It comprised monetary easing from the Bank of Japan (BOJ), fiscal stimulus through government spending and structural reforms.

While there was initial investor optimism over the reforms, the country slipped back into recession in 2020 without meeting Abe’s aim of ending deflation.

However, market watchers are broadly of the view that the latest changes in Japan will be more sustained.

The requirements this time around for Japanese companies trading below book value to come up with capital improvement plans has had the effect of benefiting shareholders.

Companies are now aiming to increase shareholder returns through share buybacks and higher dividend payouts.

The weaker yen has also boosted the economic performance of Japanese companies overseas.

High profile investments by American investor Warren Buffett in Japan in the last few years have also boosted investor confidence.

Internally, the Japanese companies are also seeing change, with a majority of them having more independent boards.

According to data from the Japan Association of Corporate Directors, 44 per cent of board seats of companies listed on the Tokyo Stock Exchange’s (TSE) prime section were occupied by outside directors, up from 28 per cent in 2017.

Between 2021 and 2022, the ratio of prime market listed companies with at least one-third of independent directors rose from 73 per cent to 92 per cent, and has held steady since, according to data from the TSE.

These changes, coupled with a return to inflation, have buoyed investor optimism that Japan has reached a turning point.

The country’s gross domestic product has emerged from two decades of stagnation with the changes, while inflation has remained above the BOJ’s target of 2 per cent for several quarters.

Getting in on the action

Nevertheless, some watchers have warned of headwinds.

Derrick Tan of Wrise Management, for example, said that with the end of its negative rate policy, Japan will now see higher interest rates. While private banks may benefit from higher lending profitability, they could also face losses on their bond holdings due to rising long-term rates.

Higher mortgage rates could also dampen Japan’s booming real estate market and reduce the profits that investors see on rental yields, he said.

Despite the potential pitfalls, it appears that it is not too late for investors to ride the Japan wave.

In its outlook for Japan published last month, Lazard Asset Management noted that Japan equities’ forward price-to-earning valuations are still around the 10-year average.

With the yen’s drastic fall, Japanese authorities have indicated that they might intervene to prop up the yen.

If the yen eventually rises, foreign investors could see the value of their shares increase.

Moreover, with the Chinese economy seeing slower growth, investors are seeking alternative opportunities in Japan, where the market is more mature, transparent and easier to navigate compared to other regional countries.

With the tide turning in Japan’s favour, there could still be much to gain for investors this year.