Benjamin Hughes

March 10, 2024 - 10:36 am

Japan's Surging Stock Market Reaches New Heights: Nikkei 225 Hits Peak Since 1989

In the land of the rising sun, a steady ascent in the financial markets has culminated in a significant milestone. The Japanese stock market, often overshadowed in headlines by the performance of U.S. equities, is experiencing a notable bull run. Last week, Japan's benchmark Nikkei 225 Index soared to its highest level since the bubble year of 1989—a remarkable zenith three decades in the making. As economic stagflation receded into the annals of history, this index surged by 19% year to date, flaunting an impressive 39% increase over the past year, thus eclipsing the S&P 500, which saw a 7.4% gain in 2024 and a 30.7% increase from the previous year.

The revitalization of Japan's equities market extends beyond domestic factors and is bolstered by the underwhelming performance of its neighbor. The economic slowdown in China has cast a shadow of pessimism, indirectly energizing Japanese stocks. Investors around the globe, turning their gaze from Chinese enterprises, have begun channeling more of their investments into Japan's market. Christopher Wood, Jefferies' head of global equity strategy, noted in a March 7 commentary the significant uptick in foreign stakeholder investment in Japan—climbing nearly eightfold to about one-third of the market since 1989, when foreign investment was a mere fraction at 4%.

The parallels between Japanese and American markets are unmistakable, as both rallies are being fueled by a concentrated group of large-cap entities. In Japan, a handful of corporations are at the forefront of this growth, riding the wave of AI and technology enthusiasm. Tokyo Electron, SoftBank, Fast Retailing, and Advantest stand out as the core drivers, collectively accounting for more than half of the Nikkei's triumphant rise in 2024. Goldman Sachs further widens the lens to spotlight a "Seven Samurai" bouquet of influential companies, including Toyota Motor, Subaru, and Mitsubishi—an acknowledgment that sector concentration is a global, not purely American, phenomenon.

Strategas Research Partners echoes this notion of sector concentration and observes that "Concentration [is] not only an American phenomenon." Meanwhile, Morgan Stanley pinpoints high-quality stocks as a force surpassing the broader market's performance this year. These "quality" stocks possess traits such as lower debt-equity ratios, higher return on equity estimations, and lesser earnings volatility. However, such stocks are not immune to economic fluctuations, trading at escalated price-to-book ratios and shouldering higher beta values—a marker for potential susceptibility to underperformance should there be an economic downturn. Morgan Stanley urges investors to be cautious, recognizing that in a market dominated by large-cap stocks, a 'quality index' could falter amidst shifts in market dynamics.

Makoto Furukawa of Morgan Stanley MUFG signals a note of caution, especially in the tech sector where Citi analysts express concerns over soaring valuations nearing apex levels. The potential saturation point of Japan's equity gains casts uncertainty over the endurance of current index-buying trends that heavily favor large caps. Ryota Sakagami from Citi suggests that a shift in stock selection may be imminent if the upswing of Japanese equities tempers and halts.

For international investors seeking to leverage upon Japan's corporate giants, the iShares MSCI Japan ETF (EWJ) serves as a gateway to the large-cap echelons of the market. With an expense ratio sitting at 0.5%, and boasting an almost 11% year-to-date total return, the prospects are promising. Moreover, the iShares JPX-Nikkei 400 ETF (JPXN) which tracks both large and mid-cap enterprises, represents an additional investment avenue. Housing a 0.48% expense ratio, JPXN has secured a commendable total return around 10.2% for 2024. Both ETFs embody the upward swing of the Japanese market and offer investors a diversified entry point.

Shifts in monetary policy have played no minor role in the recent exhilaration of the market rally. In Japan's case, the prospect of rising interest rates ushers in a new economic narrative—one that moves away from the deflationary drag that haunted Japan for decades. Persistently falling prices had suppressed consumer spending, stifled wage increases, and eroded corporate profitability. Now with economists projecting the Bank of Japan might lift the negative interest rates as soon as April, the first hike since the fiscal year 2007, investors are cheering in anticipation. This period could signal an inflection point towards inflation after enduring the long spell of deflationary insidiousness.

The turn of events with Japan's rate policy shifts could catalyze further ascension in its national equities. Sakagami of Citi accentuates this tightening of monetary policy as a pivotal driver behind the climbing equity rally and estimates a stasis at the 40,500 mark before a potential continuation of the surge, eyeing the 45,000 level. Japan's domestic dynamism may require additional catalysts to further transcend merely aligning with the U.S. market. A substantive revival in internal demand and sustained inflation are the types of unique catalysts that could propel Japanese equities to new frontiers, though it appears more time is needed before elucidating such trends.

In conclusion, as we observe the Japanese stock market carving a steep trajectory, it is imperative for investors to discern the intricate web of factors underpinning this movement. The delicate interplay between monetary policy adjustments, domestic economic revitalization, technological impact, foreign investment shifts, and market sector concentration compose the complex narrative of Japan's ascent to financial prosperity. As developments continue to unfold, analysts and investors will keenly follow how these factors converge to shape the course of the Nikkei 225 and potentially redefine the global economic landscape.

For reference and additional insights, the iShares MSCI Japan ETF EWJ and the iShares JPX-Nikkei 400 ETF JPXN provide relevant financial data and assist in understanding the investment potential within Japan's evolving equity market.

Navigational Links:

• For the most recent performance data and analysis of the iShares MSCI Japan ETF (EWJ), please visit: iwj

• To explore the companies and performance encompassed within the iShares JPX-Nikkei 400 ETF (JPXN), refer to the following link: jpxn

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