Japan's Nikkei 225 index experienced a significant decline last week, but investors see long-term opportunities.Tomohiro Ohsumi/Getty Images
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The new dawn that appeared to have finally broken for investors in the land of the rising sun has not been without a few storm clouds in recent weeks.
After the Nikkei 225 index experienced its worst day on Aug. 5 since the infamous Black Monday stock market crash in 1987, investors are left wondering if Japan truly has emerged from its decades-long slump.
“Monetary tightening measures announced by the Bank of Japan, coupled with an increasingly dovish tone from the U.S. Federal Reserve Board, led to a spike in the Japanese yen from extremely depressed levels,” says Tyler Mordy, chief executive and chief investment officer at Forstrong Global Asset Management in Toronto, about the Nikkei dropping more than 12 per cent on Aug. 5.
Japan’s cheap currency relative to the U.S. dollar had been a source of the recent resurgence of its export-oriented economy, particularly in technology and manufacturing, he adds.
Yet, the yen had also been integral to many carry trades whereby investors borrowed in yen often to buy U.S. mega-cap stocks.
“When such ‘one-way bets’ are unwound, the process can become self-reinforcing … as investors are hit with margin calls,” Mr. Mordy says.
That alone didn’t cause the global selloff this month that affected Japanese equities deeply. Fear over a U.S. recession was largely the spark, he says, and the Nikkei’s plunge was partially a reflection of growing ties between the U.S. and Japan, the world’s fourth-largest economy.
However, in the longer term, Japan appears poised for strong fundamental growth as its monetary policy normalizes, along with “repatriation of capital back into domestic markets,” Mr. Mordy says.
Until recent weeks, Japan had been a top-performing equity market to mid-year, up 15 per cent and finally surpassing its 1989 peak, rallying “against a backdrop of rising global inflation … helping pull the economy out of decades of deflation,” says Maya Funaki, portfolio manager, Asian equities, at RBC Global Asset Management (Asia) Ltd. in Hong Kong and lead portfolio manager of RBC Japanese Equity Fund.
Conditions “piqued” investor interest, she adds, further bolstered by significant reforms that could spur economic growth.
Notably, Japan has seen a massive shift in monetary policy. As most central banks hiked interest rates, the Bank of Japan (BoJ) has largely remained on the sidelines due to the economy’s longstanding battle with deflation.
Yet, the BoJ changed course this year, raising interest rates twice – first in March and again in late July – to 0.25 per cent after experiencing modest inflation.
Additionally, closer ties with the U.S. and growing investment in artificial intelligence-related technology have elevated Japan’s equity market, prompting speculation that its economic renaissance was finally at hand, Mr. Mordy says.
Conditions have been “notably benefiting pro-cyclical sectors,” he says, with the financial, industrial, energy, technology and auto sectors seeing upticks.
Trade agreements brokered with the Biden Administration also helped the investment case for Japan, especially for semiconductor manufacturing and related companies, says Jim Thorne, chief market strategist with Wellington-Altus Private Wealth Inc. in Toronto.
“This is an economy that was basically in the penalty box for decades that’s now getting out to participate in this new AI phase of global growth,” he says.
Recent changes to the corporate sector, including significant governance reform, have also made Japan more appealing to investors, Ms. Funaki says: “[The] Tokyo Stock Exchange led this first wave of change, implementing a program to encourage companies to increase disclosure and improve capital efficiency.”
As well, modifications to Japan’s tax-free savings program, aimed at encouraging domestic investment in its stock market, have proven successful. In the first quarter of 2024, the number of Nippon individual savings accounts tripled year over year, with more potential growth ahead as “household savings represent a huge untapped pool with more than 50 per cent of assets being held in cash,” she adds.
However, there are still risks, as recent market volatility illustrates, Mr. Mordy notes. Japan faces labour challenges because of its aging population and low immigration relative to other developed nations.
Geopolitics also threaten its recovery. Notable issues include the U.S. presidential election and what Donald Trump would do if elected, Mr. Thorne says, adding the Republican presidential nominee’s protectionist stance may scuttle the U.S.-Japan trade deal.
Also, the yen’s low value could become a headwind, Ms. Funaki says, as further devaluation could “hinder [Japan’s] domestic consumption recovery.”
Risks aside, Japan’s growth is built increasingly upon a rejuvenated and “thriving” semiconductor sector, Mr. Mordy says, marking a return to the more prominent role the country had in the 1980s when its production made up 50 per cent of the global market.
Health care is another growth area in which Japanese firms are “leading the charge in terms of innovation,” Ms. Funaki says.
For example, companies such as Daiichi Sankyo Co. Ltd. DSKYF, Japan’s second-largest pharmaceutical firm, are makers of ground-breaking cancer treatments.
“Hiring an active [portfolio] manager who understands Japan well” is one way for advisors to get targeted exposure to these opportunities, Mr. Thorne says.
Currency-hedged exchange-traded funds (ETFs) offer a broader tact. “The idea is to get low-cost exposure to Japanese companies but not to the yen’s volatility,” he adds.
Choices include iShares Japan Fundamental Index ETF (CAD-Hedged) CJP-NE, which provides broad exposure to the country’s equity market, including Toyota Motor Corp. TOYOF, Sony Group Corp. SNEJF and Softbank Group Corp. SFTBS, Mr. Mordy says.
Another ETF, WisdomTree Japan SmallCap Dividend Fund DFJ-A, offers access to lesser-known names with growth potential, including Nippon Electric Glass Co. Ltd. NPEGF. The leading glass manufacturer for electronics and solar energy cells is up about 30 per cent in the last year.
The ETF’s “underlying sector composition aligns well with the current pro-cyclical market,” Mr. Mordy says. Contrary to some recession forecasts, his investment team anticipates a sustained global economic expansion, benefiting cyclical sectors such as industrials, materials and financials.
All in all, investors have reason to be cautiously bullish, Mr. Thorne says: “Japan could be a big investment theme for the next decade.”
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