Japan’s poor economic performance since the late 1980s has gone hand-in-glove with an even lousier stock market. However, the 2023 recovery of the Nikkei and Topix indices to levels not seen since the start of the 1990s showed that global investors have finally begun to take the country seriously again as an investment destination.
The Topix index is a blended measure of the Japanese stock markets (Japan still maintains large regional exchanges). It soared by roughly 26% in 2023 to outperform the S&P 500 in local currency terms.
The S&P 500 is still ahead in dollar terms—which, according to Goldman Sachs analysts, explains why some dollar-denominated investors have been reluctant to increase their exposure to Japan. But that hasn’t stopped other global investors from buying up Japanese stocks.
Why Japanese Stocks Are Enjoying a Renaissance
Valuations are cheap in Japan and investors are discovering that Japan has a lot of high-quality technology and manufacturing firms, particularly in the semiconductor sector. For example, Advantest (ATEYY) is a leading manufacturer of automatic test equipment for the semiconductor industry. Its stock is up more than 100% over the past year.
The reshaping of global supply chains away from China is another plus. This could unleash a wave of foreign acquisitions of Japanese manufacturers and facilities. At the least, it is igniting interest in those companies and stocks.
In addition, authorities at the Tokyo Stock Exchange (TSE) have also been pushing hard on Japan’s many capital-inefficient companies, whose price to book (P/B) ratio is below 1. They must either shape up or face financial penalties.
Keep in mind that, at the time the TSE began its push early in 2023, more than half of all TSE stocks were trading below their book value. The reason was that there was often too high a reserve of cash. And even though the penalties are years away, companies are already starting to follow the new script. Buyback announcements hit an all-time record, and cash dividend payouts from the aforementioned cash piles are also at a record.
In simple terms, these TSE reforms are having a big impact by changing cultural expectations (becoming more shareholder friendly) of Japanese corporate management.
One other structural change that seems to be boosting competition in corporate Japan—and thereby the productivity of companies themselves—is the unwinding of crossholdings. Crossholdings between companies has been one of the main criticisms of Japan’s market for decades. But now, Goldman Sachs research shows that crossholdings have reached a low of about 10% of the book value of all companies on the stock exchange.
And, more reforms are on the way in Japan…
More Reforms to Boost Japanese Stocks
There are stock market reforms that are shaking up the way the Japanese save. In fact, the changes due to take effect in January should give small domestic investors their first significant stake in the stock market.
Japan has announced reforms to its tax-free stock market investment account, the Nisa. The overhaul will make tax relief permanent (the accounts currently have a finite period of tax exemption) and increase the amounts that accountholders can save each year.
It’s hard to predict how Japan’s notoriously conservative savers will react. Japanese savers in recent decades have rarely strayed beyond the low interest offered on Post Office bonds. But the prospect of domestic buyers of Japanese shares increasing from a low base of 30% of all stock transactions is very alluring.
Keep in mind, too, that Japan remains one of the few countries where inflation is welcomed as an economic tonic to its underlying economic stagnation.
I expect the Bank of Japan (BOJ) to end its ultra-loose monetary policy and below-zero interest rates in 2024. Domestic liquidity will need to find a home, and with the right savings account, the stock market could be a major beneficiary in 2024—especially if it continues to significantly outperform inflation.
One other thing that might tempt Japanese investors into the stock market is that earnings growth for companies has averaged just above 7% in 2023, just behind the U.S. corporate equivalent, according to MSCI data. Goldman Sachs reckons that this trend will continue through to 2025, with shareholder payout ratios, which include both dividends and share buybacks, growing to 60% of earnings. That figure would be the highest since 1995, except for the artificial spike caused by the 2008/09 financial crisis.
Japan ETF—DXJ
The rally in Japan has finally succeeded in garnering attention from U.S. retail investors away from AI.
The WisdomTree Japan Hedged Equity Fund (DXJ) is one of the larger Japan ETFs, with $2.88 billion under management. It drew an inflow of $510.7 million in the past year. The fund gained almost 37% in the past year.
Here are some of the top 10 stock positions in DXJ and the gains these stocks had over the last 52 weeks:
- Toyota Motors (TM): +32%
- Mitsubishi UFJ (MUFG)L 29%
- Shin-Etsu Chemical (SHECY): +66%
- Itochu (ITOCY): +34.11%
- Nintendo (NTDOY): +21
And with this being a hedged fund, you do not have to worry about the value of the Japanese yen affecting your investment. It has a decent yield as well, with a distribution yield of 2.75%.
I believe Japan will remain a great place to invest in 2024. DXJ is a buy anywhere in the $80s.
