Despite the recent impressive performance of Japanese stocks, investors are taking a moment to reassess their positions in the market.
Comparisons to Japan’s market status in 1989, the last time the Nikkei Stock Average reached this level, can be unsettling, as the country’s stock market bubble burst shortly after hitting that record.
The current macroeconomic outlook is uncertain, with mounting pressure on the Bank of Japan to move away from years of negative interest rates.
However, Japan’s equity story extends beyond records and rates. In fact, the country’s stock market has the potential to be a consistent performer in the long term as significant reforms steer the economy toward a positive trajectory. After grappling with deflation for three decades, Japan’s transformation is just starting.
The most promising opportunities may not be the most obvious ones. To tap into the long-term potential of Japanese stocks, investors must look beyond the current top performers and capitalize on undervalued companies.
Valuations appear reasonable despite the market’s strong performance over the past year, with a 28% gain in 2023, making Japan the best-performing market in Asia.
Furthermore, nearly half of the companies in the Tokyo Stock Exchange’s Prime section trade below their book value, compared to just 3% of those in New York’s S&P 500 index, according to Man Group calculations.
Additionally, foreign inflows of approximately 3 trillion yen ($20.3 billion) last year were well below the 15 trillion yen level seen in 2013 at the start of the Abenomics era. In dollar terms, the Nikkei average remains below its 1989 peak, thanks to the yen’s weakness.
Unlike in 1989, the current surge in Japanese stocks is supported by strong fundamental factors.
After a prolonged period of stagnation, prices are increasing, partly due to the BOJ’s ultraloose monetary policy. This is boosting corporate earnings and equity valuations. In the long term, inflation’s return will help Japan achieve economic growth by boosting wages and consumer spending.
While the expected end of negative interest rates — possibly as soon as Tuesday at the close of the BOJ’s regular monetary policy committee meeting — may lead to some short-term volatility, there are other factors driving Japan’s equity story.
The structural transformation of Japan’s economy is gaining momentum, fueled by ongoing government initiatives and the country’s most radical corporate governance reforms in a generation.
