Japanese stocks rally as investors’ rate rise fears wane

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Japanese stocks have risen to their highest levels since 1990 as investors downplay the likelihood of an interest rate increase by the Bank of Japan in the near term.

The Nikkei 225 index has gained 6.3 per cent so far in 2024 while the broad market cap-based Topix has climbed 5.4 per cent. 

This is in sharp contrast to Wall Street’s S&P 500 and Nasdaq Composite, which have been close to flat since the beginning of the year, following a steep rally at the end of 2023.

Elsewhere in Asia, China’s CSI 300 has slipped 4.3 per cent, Hong Kong’s Hang Seng has dropped 4.7 per cent and South Korea’s Kospi has dipped 4.9 per cent.

The economic impact of the deadly earthquake that shook the country’s west coast on New Year’s Day led traders in swaps markets to lose confidence that the Bank of Japan will soon exit its decades-long ultra-loose monetary policy — a move that analysts say would strengthen the yen but suppress equities in the country’s export-heavy market. 

“Japan is an especially interesting case from a behavioural perspective,” said Michael Metcalfe, head of global market strategy at State Street. “Foreign asset managers have been overweight Japanese equities for more than a year now” even though potential monetary tightening and a stronger yen “have looked like possible threats”. 

“Since November we’ve seen asset managers actually adding, rather than reducing, their overweight in Japanese equities as part of a broader re-risking in portfolios,” added Metcalfe.

Governance reforms and a rise in activist campaigns have boosted investor confidence in Japan, say analysts, while foreign investors have been seeking an alternative to China. 

Saxo Bank’s head of FX Strategy, Charu Chanana, said the current rally is likely to continue because “significant gains in the yen remain unlikely unless the Fed begins easing sooner than expected”. 

She warned, however, that Japanese stocks will struggle to replicate their outperformance last year. The Nikkei 225 gained more than 28 per cent in 2023, outpacing major equity indices in both Asia and Europe, as well as Wall Street’s benchmark S&P 500. 

Metcalfe is less confident: “The danger of BoJ tightening — and the yen strength that could bring — has been postponed for now, but the risk has not gone away.” 

Koji Toda, a fund manager at Resona Asset Management, also warned of volatility ahead, saying the strong start to the year was mostly a catch-up to the robust gains US equities made in December as concerns about a stronger yen weighed on Japanese stocks.

“The key question is whether the investor expectations are sustainable or not. The main premise of rising shares in Japan is the continuing resilience of the US economy,” said Toda.

Others remain fiercely bullish. “Less than 24 hours after a 7.5 magnitude earthquake, bullet-train lines were running again in the same region,” Bank of America analysts wrote on Tuesday. “The Japanese economy is resilient, undervalued and becoming more productive.”

Indeed, Bank of America’s chief Japan equity strategist Masashi Akutsu believes a combination of sustained inflation, corporate reforms and relatively low valuations could push the Nikkei 225 to surpass its all-time high — hit in 1989 — this year.

Maya Funaki, a portfolio manager at RBC Global Asset Management, said she still sees significant upside from undervalued equities in Japan, especially as companies continue to make improvements to shareholder value. “It feels as though change is just beginning.”

“Whilst the market has exhibited strong performance over the past 12 months, it continues to be under-owned in a global context,” added Funaki. “In 2024 — as more investors gain confidence in Japan’s virtuous cycle from positive inflation with rising corporate earnings and total shareholder return — we expect the market to continue to outperform.”