Japan has just emerged from 34 years of deflation and ended a nearly 20-year negative interest rate policy. The response of the Japanese stock market was to continue to hit record highs, rising 35% in the past year. The last time the Japanese stock market experienced such an increase was in 1989.
The Japanese stock market seems to have peaked, but if you take a closer look, you'll see that the rise in the world's third-largest stock market has only just begun. This year may be the starting point of the multi-year recovery of the Japanese stock market, and an important new capital market cycle is about to begin. With global investors looking for opportunities in Japan, an investor-friendly market, Japanese companies are only just beginning to celebrate the long-awaited return of their pricing power.
Investors should look out for two trends. First, emerging micro and macro forces are at work, and over the past few years, Japan has become the preferred investment destination outside the US. With the US dollar at a 20-year high, portfolio managers know that this is usually a time to diversify investments and buy cheaper overseas assets, but which markets should they choose? Europe is cheap but challenging, and India is currently the best performer among the BRICS (BRICS) emerging markets. With Asia accounting for 45% of global GDP, Asian exposure is important for global investment portfolios. However, strategists say we now live in a “multipolar world,” which is a euphemism for global geopolitical risk to rise to the highest level in decades. Geopolitical risk temporarily limited the allocation of Chinese assets by global investors.
However, Japan is an important security partner for the US, and is also rapidly becoming a key partner in America's “backflow” strategy, particularly as an alternative supplier of semiconductors and technical components. Another factor is the weakening of the yen. The yen is close to 152 yen against the US dollar, which is the lowest level since 1990, which means that Japan is also likely to regain the market share taken by China over the past 20 years in the fields of auto parts, industrial products, and machinery. The status of America's security partner is now important to investors, which will keep investors' allocation to Japan at a high level for a longer period of time.
Second, although Japan is a mature developed economy, due to the differentiated structure of the Japanese stock market, it may bring more alpha opportunities to investors. In the US, large capitalization stocks and the “Big Seven” dominate the stock market, and exchange-traded funds (ETFs) also prefer large cap stocks over small to medium cap stocks. However, the largest companies in the Japanese stock market have not changed; with the exception of SoftBank, all companies were founded before 1960.
According to data from Abrdn Investments, 45% of the 2000 constituent stocks of Japan's benchmark Tokyo Stock Exchange Index were not covered by analysts, while the ratio of the US Russell 3000 Index was only 3%. At a time when inflation stimulates economic growth, these unexpected increases and changes in Japanese companies' profits, which have not been fully studied, will provide investors with the opportunity to obtain higher alpha returns.
Furthermore, the Japanese government and the Tokyo Stock Exchange have initiated important corporate governance reforms, and 26% of listed companies have submitted specific plans to improve stock valuations, yet many companies have yet to respond, which brings more opportunities for investors.
The breakdown of Japan's nearly 3,900 stocks is very illustrative. So far this year, Japanese mid-cap stocks and small-cap stocks have outperformed large-cap stocks by 40% and 60%, respectively, with one-year losses of 25% and 46%, respectively.
It's one thing for small to medium cap stocks to outperform large cap stocks, but for many investors who have never seen Japan's inflation, wage growth, and domestic sales growth, they may find a series of new stocks with interesting characteristics, such as the following three:
Organo (Organo) is a water treatment company with a market capitalization of 2 billion dollars, and daily stock turnover sometimes exceeds 60 million US dollars. TSMC is one of the key customers that the company relies on for growth.
Nakanishi is a manufacturer of dental equipment and precision tools with a market value of 1.5 billion dollars. Last year's revenue increased 23%, dividend ratio was 2.5%, return on net assets was 24%, and net cash accounted for 12% of the stock price.
Chugoku Marine Paints (Chugoku Marine Paints) is one of the top three marine paint manufacturers in the world. It has a 20% global market share and a 15% return on investment capital, a price-earnings ratio of nearly 11 times, and a dividend ratio of 2.6%.
Overall, the analysis found that the share price of nearly 100 Japanese companies with a market value of more than 1 billion US dollars accounted for 20% or more of net cash.
Most importantly, Japan's culture of innovation, combined with the end of deflation, could bring about a new wave of capitalization. In a period of deflation that has continued for decades, businesses and consumers are increasing savings and reducing spending and investment, but at a time when Japan's nominal GDP growth rate reaches 5% and wage growth reaches record levels, inflation will stimulate new capital investment and bring about a new investment banking financing cycle.
This outlook is also risky. The double-digit increase may cause the stock market to fall. Furthermore, investors should pay attention to the threat faced by Japan's inflation level, exchange rate level, and willingness to reform. But the most important thing for investors is to recognize that in an ever-changing world, Japan has changed a great deal.
Editor/Jeffrey