Will the Japanese stock market rally endure?

Written by Kapronasia || June 13 2023

Japan’s stock market rally is a pleasant surprise amid intense geopolitical tensions in its neighborhood and a tough year overall for capital markets. It seems global investors have a renewed faith in Japan Inc. The Nikkei has notched a 14% gain so far this quarter, reaching a 33-year high in early June. Up 22% this year, the Japanese benchmark is way ahead of most of its peers. Though some analysts say that structural problems in the Japanese economy could ultimately diminish investor interest in Japanese stocks, for now the market remains red hot, with yet another boost from better-than-expected GDP growth in the first quarter.

Japan’s economy expanded at an annualized rate of 2.7% in the first quarter of the year, beating estimates of 1.6% made in May. Economists surveyed by Reuters had expected to see growth of 1.9%. Private non-residential investment, or capital spending, rose 1.4% — higher than initial government estimates of 0.9%. Private demand rose by 1.2% and domestic demand rose by 1%.

The short-term outlook for Japan’s stock market looks good given solid economic growth. Further, the Bank of Japan is maintaining its accommodative policy stance and expects inflation to ease in the second half of this year. At the same time, a weaker yen benefits exports, an important economic driver for Japan.  

There are other reasons to be bullish about Japanese stocks. On the one hand, investors are optimistic about Japan relative to the United States and Europe, as it does not face an imminent recession and yet has very low valuations. Further, companies in Japan are strengthening their balance sheets and giving back to shareholders with buybacks and dividends.

Nevertheless, local investors have been less enthusiastic about Japanese stocks than their foreign counterparts. According to Reuters, in April and May, domestic outflows totaled around 2 trillion yen ($14.81 billion) for individual investors and over 2.2 trillion yen for Japanese institutions. Domestic investors do not share the same excitement as foreign investors about a prospective new era of growth for corporate Japan, and seem eager to cash out now – while doing so is profitable. This is a strategy that Japanese investors have developed over many years of ephemeral rallies in Japanese capital markets.

Reuters notes that this long stock market rally has confounded some local investors that bet heavily on so-called “double-inverse” exchange traded funds (ETFs) managed by some of Japan’s largest asset managers that double their returns if the benchmark falls. They are designed for short-term investors and pay them double the opposite of the Nikkei’s daily declines by taking short positions in Nikkei futures.