Investors Should Favor Japanese Stocks After Turnaround, Strategists Say

For a long time, Japan was the prime example of secular decline—an aging population, a slow-growing economy, deflation. But now there’s a compelling argument to be made that the Land of the Rising Sun, which, after all, is the world’s third-largest economy, has welcomed a new dawn—and offers alluring equity opportunities.

The catalyst is a corporate governance makeover and a shareholder activism surge, so it makes sense for investors to increase their exposure to Japanese stocks, according to many strategists. They believe that Japan’s market has an upward trend going and are pleased that its shares remain affordable: The Tokyo Stock Price Index, or TOPIX, is ahead 22% this year, beating the S&P 500’s 13.5%; the Japanese index has a price/earnings ratio of 16.2, a better value than the U.S. benchmark’s 21.5.

“Even though Japanese equities have rallied nearly 20% this year, we see structural tailwinds for further strong performance,” declared a research paper from J.P. Morgan Asset Management. Spurring the optimism is a pickup in corporate capital spending, the firm found.

Another plus is that longstanding deflation, or at best tiny inflation growth (less than 1%), seems to be gone, as a note from analysts at asset manager Schroders PLC spelled out: “Deflation leads companies and consumers to delay investment and put off purchases; there’s little point buying something now if it will be cheaper tomorrow.”

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After finally running tiny inflation during the last decade, Japan switched back to mostly deflation in recent years—but in 2022 solid price raises returned, up 2.7%, with annual inflation for 2023 running at a 3.2% rate.

Japan’s companies now are more efficient at delivering value to investors, thanks to a rise in stock buybacks and dividends, says Jeffrey Buchbinder, chief equity strategist at LPL Financial. The Tokyo exchange has pressured member companies to “increase shareholder returns, and that’s been like a hockey stick pointing up,” he adds. The market in Japan “has had a real cultural shift.”

For U.S. investors, of course, the strong dollar is a big enticement to buy Japanese stocks. Since 2021, the yen has depreciated by one-third compared with the greenback. The Bank of Japan’s continued commitment to low rates means that the yen is unlikely to appreciate anytime soon, the JPM note reasoned.

A prominent Tokyo-based investment firm, Nikko Asset Management, is pushing the case that Japan’s stocks deserve more attention because the nation has a “stable political backdrop,” with the Liberal Democratic Party and a small ally firmly in control of parliament since 2012. “This climate of no surprises has helped create a favorable environment for businesses and long-term investors,” the firm stated in a report.

“In an era of increased polarization, Japan’s political environment is known for its stability and political continuity,” per the report. It did not need to spell out the contrast between Japan’s situation and the conditions in Washington, where the speaker of the House of Representatives was ousted last week.

Meanwhile, the Nikko paper pointed out, the new emphasis on expanding shareholder value is helpful to Japan’s stocks. It asserted that “corporate accountability has become a growing theme in Japan.”

It also pointed to the 2022 investor revolt against the management of Canon Global, a colossus that makes cameras, semiconductors and other tech products. Fujio Matari, Canon’s chief executive and chair, barely won re-election amid complaints that the company had no women on its board. Afterward, the company pledged to add its first female director, finally nominating Ito Akiko last month.

All things considered, Nikko argued that investors nowadays will find “a lot of value in the Japanese equity market.”