Rumors have been swirling about potential monetary tightening measures by the Bank of Japan (BOJ), but for now, those rumors have been proven to be exaggerated. This comes as good news for Japanese stocks, although there are still some concerns.
Despite being known for deflation, Japan has experienced unheard-of price increases lately, with core inflation remaining above 3% annually for the past year. BOJ Governor Kazuo Ueda hinted in a press interview three weeks ago that the bank might respond by raising its prime interest rate, which caused a brief surge in the value of the yen. However, at a policy meeting on September 21, the bank ultimately decided to maintain its current rate due to what they referred to as “extremely high uncertainties.” As a result, the yen once again plunged towards a record low of 150 to the dollar.
It’s worth noting that the BOJ had previously intervened at this level last fall, and as U.S. Treasury yields slumped, the yen climbed 17% in just three months.
This time around, Ueda and his colleagues are taking a more patient approach. They want to see if workers can secure wage hikes from Japanese corporations during negotiations next spring. According to Masamichi Adachi, the chief Japan economist at UBS, they still believe that any inflation may only be temporary. Adachi explains, “The economy is not overheating yet.”
While in most cases, a weak currency would be detrimental to equities, Japan’s market is unique. The country’s market is heavily influenced by exporters such as Toyota Motor, Sony Group, and industrial equipment giant Keyence. These companies have benefited greatly from the declining yen and the strong demand from both the U.S. and Europe. In fact, the iShares MSCI Japan exchange-traded fund has seen a remarkable 22% increase in the past 12 months, surpassing the 16% rise in the S&P 500.
According to Daniel Hurley, a portfolio specialist for international equities at T. Rowe Price, more gains are on the horizon as long as the U.S. economy continues to perform well. He explains, “Half the revenue for listed Japanese companies comes from outside Japan. It’s still set up to be a supported market.”
Japan’s Promising Macroeconomic Situation
According to Aaron Hurd, the senior currency portfolio manager at State Street Global Advisors, Japan has found itself in a favorable macroeconomic situation. While the value of the yen remains at a record-low, falling prices of most import commodities (excluding oil) have alleviated some of the concerns. To further support consumers, Prime Minister Fumio Kishida’s government plans to subsidize fuel costs by borrowing at an incredibly low annual interest rate of less than 1%.
Although a potential recession in the United States may dampen Japanese exports, it could also lead to Federal Reserve rate cuts that would strengthen the yen. This situation has led Hurd to predict that the yen could become one of the top-performing currencies among the G10 nations, potentially reaching a rate of 155 to 158 to the dollar.
Investors are particularly impressed by Japan’s efforts to prioritize shareholder and inflation interests within companies. Earlier this year, the Tokyo Stock Exchange implemented sanctions against companies whose market capitalization fell below their book value. This movement towards shareholder-friendliness has already yielded positive results, as exemplified by Toyota’s 50% surge in market value year-to-date. Additionally, Prime Minister Kishida is actively promoting a “new capitalism” program that aims to increase the minimum wage by 4% and enhance flexible employment opportunities.
Katrina Dudley, a portfolio manager at Franklin Templeton, expresses her belief that this time, Japan is truly experiencing a different economic landscape. Consequently, her exposure to Japanese investments has increased.
While some market players, including BOJ Gov. Ueda, prefer to wait for additional data before making any substantial moves, others have become more cautious about Japan’s prospects. Cameron Brandt, the chief of research at financial flows monitor EPFR, acknowledges that past disappointments have made professional money managers more wary.
Nevertheless, it is safe to say that Japan, as the world’s third-largest economy, is moving in the right direction. This is particularly significant given the financial struggles and political threats facing China, the second-largest economy.
With falling import prices and potential yen strengthening due to U.S. recession and Federal Reserve rate cuts, Japan’s macroeconomic situation presents promising opportunities. Additionally, efforts to enhance shareholder focus and attract inflation-friendly investments have gained recognition from both domestic and international investors. Although cautiousness remains due to past disappointments, Japan’s journey towards economic revitalization is a positive development given the challenges faced by other major economies.