Japanese equities have rallied strongly since April 2023, outperforming global equities and only lagging behind their US peers. The market began to lose momentum in Q2 2024 as overseas investors moved to pocket their gains. But even as the strong performance has moderated, investors maintain a relatively optimistic attitude towards the market for the long term.
Japanese companies posted a robust performance in FY23-24, with high-teens earnings growth. This was driven by the weak Japanese yen, an acceleration in positive governance developments, and the end of deflation as the central bank ended its negative interest rate policy in March, according to Lazard Asset Management’s latest Outlook on Japan.
With total returns of 41% in local currency and 24% in US dollar terms, Japanese stocks outperformed most markets globally except the US, amid a strong sentiment for artificial intelligence and technology, according to the report.
However, the Nikkei Stock Average fell by 1.9% in Q2 2024 compared with the previous three months, marking its first quarterly decline since Q3 2023. The index rebounded in July, reaching a historical high on July 11, but the growth was not sustained.
The equity market took a long breather from April to June as investors digested companies’ weaker-than-expected guidance for the new fiscal year. In aggregate, companies in the Tokyo Price Index (Topix) have forecasted a low single-digit revenue growth and a low single-digit decline in earnings for FY24-25, according to Lazard AM.
Headwinds and tailwinds
Going forward, Lazard AM mentions a few potential headwinds that may pose risks to the Japanese market. These include slowing US economic growth and the Federal Reserve's interest rate path, which is tightly associated with investor sentiment in Japan. The US presidential election will also begin to weigh on the overall market mood. In Japan, the Liberal Democratic Party (LDP) leadership election in September is likely to raise concerns about policy continuity if Prime Minister Fumio Kishida is unable to secure another term as LDP president. The recent depreciation of the yen from 150 to 160 to the US dollar has also dampened investor sentiment.
On the other hand, there are many potential tailwinds for the market, according to Lazard AM’s analysis. These include unexpected positive earnings following a recent recalibration of expectations. In addition, positive governance developments have resulted in a sharp acceleration in share repurchase announcements year to date.
The Japanese government also offers policy support to encourage retail investment. The Nippon Individual Savings Account (Nisa), a tax-exempt government investment account, is designed to woo households to move their cash and savings into stocks and mutual funds. Introduced in January 2024, the new Nisa offers an unlimited tax-saving period and a higher annual investment limit of 3.6 million yen (US$23,042).
Another rate hike by the Bank of Japan would also be a positive development, as it would represent another step towards economic normalization and possibly support the yen. Fundamentals remain firm for many industries, and inventory corrections, which have dogged many businesses for well over a year, are now making headway.
This balanced near-term outlook may result in sideways movement in the equity market. Lazard AM remains upbeat over the medium and long term for Japanese equities as it expects two key themes to continue playing out: corporate governance improvement driving better capital efficiency and higher shareholder return, and the shift from deflation to inflation gradually transforming consumer behaviour.
Sumitomo Mitsui DS Asset Management, one of the largest investment management companies in Japan, holds a similar opinion in its June 2024 report. It believes that corporate earnings and favourable economic conditions will continue to drive the Japanese stock market higher in the days ahead. The solid increase in nominal GDP and the accelerating manufacturers’ business cycle could boost earnings per share in the medium to long term. The company maintains its price target for the Nikkei 225 at 44,900 yen and that for Topix at 3,100 yen to the end of March 2025.
