Could Japan’s stock market return to its 1989 peak? The question echoes worldwide investors as Tokyo’s market index outperforms its global counterparts. Rewind to 1989 when Japan’s stock market peaked, with the Nikkei 225 Index near the 40,000-point high. Now, after three decades of relatively subdued growth, Japan’s market is meeting its renaissance moment.
Champion in the Global Markets
Japan’s stock market surge crowned it the champion in the global arena during the first half of this year. Among the 15 biggest markets worldwide, the Nikkei 225 index outshone all, soaring 27% since the end of last year, the highest in 33 years.
But what led to this resurgence? A question that takes us back to 1990. The Nikkei 225 index, starting from 40,000 points, saw a decline that lasted almost two decades, hitting rock bottom at around 7,000 points in 2009. The main reason for this slide was Japan’s slow GDP growth and serious deflation for the past 30 years. However, since 2012, Japan’s nominal GDP began to grow, and over the past decade until 2021, the cumulative returns of Japanese stocks surpassed even the S&P 500 index.
Reviving Tourism and Trade
This year, the Japanese stock market experienced exceptional growth due to events that positively impacted the economy. In contrast to the US and Europe, Japan maintained stringent COVID-19 controls until fully reopening to foreign tourists in October 2022. Another factor was China’s late lifting of COVID-19 restrictions. This delay indirectly benefited the Japanese market, given the significant proportion of Chinese tourists and the crucial trade relationships between the two countries. This circumstance spurred the gradual recovery of domestic tourism, revitalizing small businesses in Japan’s travel, leisure, and hotel sectors.
The Inflation and Economic Growth
The benefits of lifting pandemic restrictions are one-off, but underpinning the long-term growth of Japan’s stock market is the much-anticipated return of inflation. After 30 years of low inflation or deflation, mild inflation is a boon for the Japanese economy. Deflation can cause enterprises and consumers to delay investments and purchases as they expect future prices to be lower. In contrast, moderate inflation bolsters corporate confidence in future investments and stimulates consumers to increase spending.
Look at Toyota’s recent purchase of 150 billion yen worth of shares. When companies buy back shares on a large scale, it makes them more scarce and can drive up the price of the remaining shares. Notably, 50% of Japanese companies have a net cash capital structure, where the cash on the balance sheets exceeds liabilities. This capability allows them to invest idle cash directly into business operations or share buybacks, thereby increasing shareholder returns.
Growing Personal and Foreign Investment
There’s a shift happening; personal investors are returning to the Japanese stock market. Data released on July 6th, 2022, by the Tokyo Stock Exchange and other Japanese exchanges showed the individual shareholding ratio rose for the first time in two years to 17.6%—the highest in nine years. An era of volatile market conditions has individuals buying low and selling high, with an increasing trend among Japanese youth to get involved in asset management.
Meanwhile, the foreign shareholding ratio in Japanese stocks stands at 30.1%. This figure represents a slight dip of 0.3 percentage points from the previous year but has remained above 30% for three consecutive years. For instance, investment titan Warren Buffett has been increasing holdings in Japanese trading companies, with Berkshire Hathaway revealing an average holding ratio exceeding 8.5% across five trading companies.
Undervalued Small Companies Have Big Potential
While the recent rally in Japan’s stock market has been driven mainly by large-cap stocks, smaller companies still have a significant appeal due to their undervalued status. Historically, mid and small-sized Japanese firms have been valued lower than large companies, as evidenced by their price-to-book ratios. However, with the Tokyo Stock Exchange’s reform initiative and investors’ return to Japanese stocks, smaller firms may see a greater potential improvement in these ratios.
With half of Japan’s household savings sitting in banks at negative interest rates, it’s time for some citizens to consider transferring their savings into the stock market. As more people choose to invest, the market will likely gain momentum, signifying a promising future for the market.
However, we should remember that Japanese stocks tend to leap when the yen takes a dip in history. Therefore, investors are advised to pay heed to exchange rate hedging to mitigate the risks tied to currency fluctuations while seizing the unique investment opportunities in Japanese stocks.