(News Bulletin 247) – The Nikkei 225 is off to an excellent start to the year. Key rates which could remain at low rates as well as the improvement in investors’ perception of Japanese markets risk prolonging the rally.

Long ignored by international investors despite having high quality companies, Japan has forced the market to reconsider its stock market existence in recent months.

The Nikkei 225, the main stock market index of the Tokyo Stock Exchange, is moving at levels not seen in more than 34 years, and has gained more than 28% in 2023. And, in the month of January 2024, the Japanese index gained 8, 4%, compared to 1.6% for the S&P 500 and 1.5% for the CAC 40. No major global index comes remotely close to rivaling this performance.

The enthusiasm around Japanese stocks has therefore existed for several months and has consolidated in recent weeks.

The Japanese economy is clearly more attractive than in the past, when the country of the rising sun combined anemic growth with low or even negative inflation. The International Monetary Fund expects growth of 0.9% in 2024 after 2% in 2023, an encouraging figure in this period of economic slowdown while inflation is expected to be around 2.9%.

Beyond economic fundamentals, the Japanese stock market is helped by a weak yen, which supports its companies’ exports, and other factors.

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“Anywhere but China”

The agony of the Chinese markets, which continue to fall – the CSI 300 which brings together the largest capitalizations of the Shenzhen and Shanghai markets plunges by 21% over one year – is playing a role.

Bank of America thus underlined in a recent note that Japan benefited from a phenomenon called “ABC”, for “anywhere but China”. Which means, in short, that investors are placing their liquidity in Japan, among others, to the detriment of the Chinese markets which have suffered them in recent years.

The Japanese Stock Exchange has also taken measures to improve the transparency and performance of listed groups in the eyes of foreign investors. The Tokyo Stock Exchange has notably asked companies that trade on the stock market at a level below their book value (a price-to-book ratio less than 1) to deliver a plan to improve their performance.

The stock exchange operator also published on January 15 a list of Japanese listed companies which have launched plans to improve their capital performance or which plan to do so. According to Bloomberg, 40% of Japanese companies listed on the “prime section” of the Tokyo Stock Exchange have communicated such plans. This “prime section” constitutes, in a way, the elite of the Tokyo market and “mainly covers companies active at the international level”, explained the Japan Times last year, with more than 1,650 companies in this category, according to UBS.

The Swiss bank noted that groups indicating that they “considered” taking such actions to improve the efficiency of their capital had experienced positive performance on the stock market after the announcement.

“This means that the Tokyo Stock Exchange listing has reinforced market expectations that companies plan to pay more attention to their cost of capital,” she deduces.

“We believe that the pressure on companies to improve their governance will continue and will not be temporary,” UBS also concludes in light of this first list (which will be updated every month).

What intentions for the Bank of Japan

After such progress, the question of the potential of Japanese stocks obviously arises. But financial intermediaries seem rather optimistic.

Bank of America believes that Japanese markets should continue to benefit from weakness in Chinese markets as well as other factors. Notably the fact that Japanese stocks are still largely underweighted in the managers’ portfolio, at 5.5% in the MSCI ACWI index (“All country world index”) compared to 44% in 1989, before the breakup. of the country’s economic bubble.

Additionally, the lower yen could further support these stocks. This will, of course, depend on the Bank of Japan. During its last meeting in January, the Japanese central bank suggested a change in policy, underlines Bloomberg, with the possibility of raising its short-term rate, which is still negative (-0.1%), with the market hesitant on a 0.1% increase in the rate in April or July. But UBS explains that it “would not be surprised” if the Bank of Japan then maintains a rate of 0% for the whole year. This could allow the yen to remain at a sufficiently low level.

Kenji Abe, strategist at Daiwa Securities, quoted by Reuters, sees the Nikkei 225 ending the year at 40,000 points compared to just over 36,000 currently.

“Shunto” as a catalyst

UBS, in a detailed pitch in November, also recommended that investors position themselves on Japan, due to improved corporate governance but also for other reasons. The bank notes that 54% of Japan’s financial assets are held in cash and only 12% in equity markets. However, Japan has now entered a phase of structural inflation, with wage growth expected around 1.5%-2% per year over the medium term.

“Real rates should therefore remain negative for the next two years. This will lead to a transfer of liquidity (cash, editor’s note) towards real assets (i.e. stocks, real estate),” anticipates she said.

In addition, cyclical securities are very important within Japanese stocks (a weighting of 44% compared to 22% normally for other places), notes UBS. Conclusion: “if (contrary to our central hypothesis) we are simply at the end of a mid-cycle slowdown, then Japan, which has the highest operating leverage of all major markets, should benefit,” explains the establishment.

“All the stars seem aligned for Japanese stocks,” Yeap Jun Ring, market strategist at IG Markets, told CNBC in mid-January.

An element of attention to watch in the coming months: the “shunto” (“spring struggle”), that is to say the social negotiations between unions and employers from March-April on wages and living conditions.

“This year, during the crucial spring wage negotiations (Shunto), wage increases are expected to exceed those of last year, which were the highest in 30 years,” explains Bank of America. The American establishment judges that these increases should reach around 2.5% or even 3% over one year and constitute the major catalyst for the first half of the year for Japanese stocks.

“The rise in real wages leads to an improvement in consumer morale, which makes it easier for companies to increase their prices and contributes to improving margins and returns on equity,” the bank explains.

Last year, Shunto caused the Japanese stock market rally, because it confirmed the end of the country’s deflationary spiral.