During the first quarter of this year, the Japanese equity market performed its strongest quarterly in a decade in terms of local currency.
The broad Topix index rose by close to 17% over the quarter as optimism around the asset class deepened.
Unlike the US equity market, which saw roughly half of its first quarter gains concentrated around the AI theme, gains in Japan were relatively broad-based. The biggest contribution came from auto stocks, thanks to a 46% rally from Toyota Motor.
Beyond autos, trading companies, financials and real estate were all strong contributors. Whilst pockets of notable AI-linked enthusiasm pervaded in the quarter in Japan, the dominant driver of market performance was company earnings combined with growing confidence in the “capital improvement” theme.
In the first quarter, notable developments from Japan include observers eagerly monitoring whether retail investors have utilised the increased tax-free savings limits for stock market investing following the revision of the Nippon Individual Savings Account (NISA) scheme on Jan 1.
We only have data for January and February, but so far, inflows into NISA accounts have roughly tripled year-on-year to approximately JPY1.7 trillion ($14.8 billion), with almost half of that inflow going to domestic stocks. The NISA regime change was never going to unleash a “financial tsunami” of inflows, but it has increased household interest and participation in the domestic stock market, a helpful and healthy development for the market.
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Yen exchange rate
The yen exchange rate has also been a hot topic in 2024. The currency continues to confound the pundits. Most observers believe the yen is too cheap and will strengthen from here thanks to rising rates in Japan versus peak rates in Western economies. However, following the Bank of Japan finally announcing a well-anticipated, if modest, increase in interest rates in March, the currency weakened further.
Corporate reform is driving productivity growth in Japan. This and a narrowing of interest differentials leave us sympathetic to the consensus view that the yen is too cheap. That said, we also acknowledge we have no edge in currency forecasting and continue to build a portfolio designed to be broadly unimpacted by currency outcomes.
Wages have also been a KPI that Japan observers are paying attention to. Signalling not just improved consumption prospects, higher wages have also been seen as a signal of rising “animal spirits” and a dismantling of the old state-led economic model. On this front, it is notable that in March, the Japanese Trade Union Confederation announced that large-sized companies have agreed to an average wage hike of 5.25%, the largest increase in 33 years.
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Higher wages
Prime Minister Fumio Kishida stated publicly in late March that he is dedicated to maintaining wage increases beyond 2025. This was taken positively by the market.
Although the Kishida administration has worked hard to support higher wages, the administration’s approval rating remains alarmingly low at around 20% to 25%. Public trust has been eroded by the political-funding scandal that emerged in 2023.
The administration now faces a critical few months ahead. If Kishida’s party loses the Lower House by-elections in late April, calls for his resignation will likely emerge. Like other major economies, the election dynamics in Japan this year offer ample scope for surprises.
We need to acknowledge the valuation expansion in Japan in the past year or so. At the start of 2023, the Japanese market was too cheap versus the existing earnings power, irrespective of the corporate reform dynamic, which will help drive strong long-term compounding gains from Japanese equities.
Over a year later, excessive undervaluation has been removed for many large-cap stocks. The long-term opportunity from corporate restructuring and balance sheet reform remains firmly intact, and the pace of reform continues to accelerate.
Carl Vine is co-head of Asia Pacific equities at M&G Investments
