By Nicholas Price, manager of Fidelity Japan trust
There’s a major shift underway in Japan. After 34 years, the country’s stockmarket has climbed past its previous record high and made history in the process. This reflects signs of a blossoming in the economy as deflation appears defeated and companies embrace the interests of shareholders.
Following a powerful rally in the first few weeks of 2024, the Nikkei 225 – a key market index – climbed back to levels last reached in 1989, before the country’s asset price bubble burst. There is real optimism that the ingredients are in place for stocks to continue to rise.
Breaching the previous high marks a watershed for Japan. Yet what is hardly noticed is that the Japanese stockmarket has quietly been one of the world’s best performers over the past 10-15 years – fuelled by steady growth in company profits and corporate governance reforms that started in 2015 under Prime Minister Shinzo Abe (known as ‘Abenomics’) rather than the fickle rises in stock valuations seen in other countries.
See also: Will bumpy inflation figures defer the interest rate cuts markets hope for?
Over the past 10 years to the end of February 2024, Japan’s broad-based Topix index generated an annualised return of 9.6% (in UK pounds), outstripping the MSCI Asia (ex-Japan) index’s 7.3%. What’s more, it also exceeded the FTSE 100 index’s 5.1% return over the period.
A new era of opportunity
In a sign of springtime for corporate Japan, a fresh era of governance improvements is underway. In 2023, the Tokyo Stock Exchange (TSE) started to push companies to unlock their market value through better use of capital. Broadly speaking, it encouraged them to think about their capital efficiency, reduce cross shareholdings and restructure businesses that are not performing.
Since January, the TSE has been publishing lists of companies making positive changes every month, and in Japan this kind of pressure works. As momentum for improving shareholder returns spreads across TSE companies, the valuations of Japanese stocks may rise.
Japan’s price-to-book ratio (measured on the Topix index) remains at a steep discount and the price-to-earnings ratio of around 14 times 2025’s earnings forecasts does not look expensive relative to history, especially considering current interest rates. Both price-to-book and price-to-earnings ratios are key measures for judging a stock market’s value – the former comparing stock prices with book value and the latter against earnings per share.
See also: The income-generating trust sector trading at ‘ridiculous discounts’
But a major driver of the country’s corporate revival is also the return to moderate inflation after years of flat and falling prices. In its most recent Outlook for Economic Activity and Prices report, the Bank of Japan forecast that core inflation will exceed its 2% target through fiscal 2024.
This shift towards moderate inflation and its impact on the spending and investment decisions made by households and corporates is a very positive trend. It is also creating new opportunities for domestic industries that can increasingly raise prices and boost profit margins for the first time in many years.
True, the economy slipped into a technical recession in the second half of 2023, but Japan still saw the strongest rate of annual growth in nominal gross domestic product since 1991. What’s more, this is unlikely to derail the country’s long-term return to moderate inflation and economic normality.
Will growth stocks recover their premium rating?
So far, Japan’s stockmarket revival has been led by its large companies, partly influenced by the US interest rate cycle and the weakness of the yen, as well as renewed buying by overseas investors. As US rates peak, and investor interest broadens further down the market-cap scale, medium-sized and smaller companies with faster earnings growth should be back in vogue.
As Japan’s stockmarket celebrates, it looks to have a fair wind. Corporates are generating steady earnings growth and the market trades on a reasonable forward valuation. Furthermore, the TSE’s corporate governance push is bearing fruit, while a return to inflation is bolstering profit margins.
Will the land of the rising sun continue to quietly deliver returns? There can be no guarantees, but no other country has such a robust combination of economic renaissance, governance reforms and positive corporate fundamentals. Despite 2024’s new high, Japan’s potential is yet to be fully recognised in stock prices.
See also: Is UK inflation is ‘finally coming to heel’? CPI data falls to 3.4% for February
