Japan equities 2024 outlook

The Japanese equity market (the TOPIX price index) gained 25% in local currency terms this year as of 30 November¹ supported by multiple factors including the long-awaited economic and border reopening, the Bank of Japan’s (BoJ) sustained monetary policy support and resultant weakening yen, auto production recovery from semiconductor shortages, and the Tokyo Stock Exchange’s (TSE) step-up of its corporate governance reform efforts.

Looking ahead to 2024, we are convinced that the uptrend will continue, and it is not a pipe dream that the Japanese equity market will finally exceed the peak of the asset bubble era in 1989.

To make the dream come true, it is pivotal that the current nominal GDP growth is sustained, where the Bank of Japan’s (BoJ) monetary policy plays a critical role.

Is the growth sustained?

Japan’s nominal GDP growth has stagnated for decades, but it significantly improved in 2023, breaking the range over the last two decades due to inflation comeback, which was translated into solid corporate earnings growth, currently outpacing the global peers.

The latest GDP readings from July to September demonstrated a growth pause. The core Consumer Price Index (CPI) (excluding fresh foods and energy) is currently at around 4%², but nominal wage hikes have yet to catch up with it, squeezing household spending power. Besides, while Japanese companies have increasing needs for capital expenditure, they take a wait-and-see attitude amid rising material costs.

Japan needs reflation, but too much inflation cools off private sector sentiment. With commodity prices peaking and Europe and China slowing down, we are certain that the high-for-Japan inflationary pressure will eventually ease. 

Furthermore, we have a constructive view on real wages - the “Shunto” spring wage negotiations between labor unions and employers should lead to another successful pay rise next year, given that Japanese companies have enjoyed robust corporate earnings growth and are under great political pressure to increase labor distributions, which have been declining for decades. We are aware of the hyperinflation risk, but it is not our main scenario.

The future of monetary policy normalization

The importance of the BoJ’s monetary policy normalization path to foster sustained reflation without either overshooting inflation or overkilling the economy cannot be overstressed. The biggest risk scenario for the bank would come from overseas, namely the US economy’s hard landing and/or China’s bottom falling out.

The US hard landing will force the US Federal Reserve (Fed) to cut rates significantly. The resultant sharply narrowing monetary policy gap will increase the risk of acute Japanese yen appreciation. Historically, the significant yen appreciation within a short period of time had led to monetary tightening effects as a plunge in import prices induced a deflationary impulse, lowering inflation expectations among both corporations and households and sparking a vicious circle.

Accordingly, to protect the economy, the BoJ would need to give up the monetary policy normalization. China’s free-fall would also significantly reduce global demand and put disinflationary pressure globally, where Japan is no exception, preventing the bank from moving forward.

We believe the US is more likely to experience a soft landing, which should not derail the BoJ’s policy normalization. The current policy rate gap between Japan and the US is significant, -0.1% vs. 5.5%.³ Along with the US soft-landing, the Fed will trim rates, but the gap would remain, which we believe contains the upside of the Japanese yen. If the yen appreciates to around the JPY130 mark against the US dollar, which is close to the calendar year 2022 average, it is still a comfort level for Japanese exporters.

At the same time, it helps to alleviate current high-for-Japan inflationary pressure. Moderation in CPI is positive for real wages among Japanese households. Furthermore, we expect Japanese corporate to resume capital expenditure plans anyway to tackle labor shortages and recover from chronic underinvestment after Japan’s asset bubble burst.

These developments would finally create a wage-price spiral which Japan is desperately in need of. Then, there is a good chance that the BoJ can finally exit from a negative interest rate policy (NIRT) since January 2016 at some point in 2024.

Government reforms throughout the investment chain

On top of economic growth recovery, Japan has been pushing through structural reforms to the entire investment chain. Following the corporate governance reform initiated in 2014 under Abenomics, the Tokyo Stock Exchange (TSE) geared up its initiatives to improve capital efficiency among listed companies, which was the biggest positive surprise in 2023.

This is not a one-off action as the TSE followed up regularly. The exchange pointed out the slower progress among companies traded above their book values or smaller companies in August and decided to publish the list to demonstrate which listed companies meet the TSE’s request to disclose capital efficiency improvement assessments, plans and initiatives from next January in October. 

Initially, the TSE’s reform spotlit value stocks only. Admittedly, it will be a step-by-step development, but we expect the initiative to eventually expand to all listed companies as the stock exchange aims - the TSE’s goal is not to achieve a one-off rise in shareholder return among stocks traded below book value but to ensure sustained corporate value growth among all its listed companies.

This move also coincides with the government’s decision to enhance its tax exemption saving account scheme, or NISA (Nippon Investment Savings Account), which is launched in January 2024 to facilitate the shift from household financial assets to investments under Prime Minister (PM) Fumio Kishida’s Doubling Asset-Based Income Plan in November 2022.

The government’s initial target is to double the number of NISA accounts to 34 million and the amount invested to JPY 58 trillion (approximately USD 400 billion) in five years.⁴ At the same time, households have also gradually been shifting their investment priorities away from safety toward profitability, as cash is no longer king amid emerging inflation.

Again, the change takes time, but the government reform combined with inflationary environments has set up a stage for the shift to investment from cash and savings, which still account for 54% of households’ financial assets of JPY 2000 trillion (approximately USD 140 trillion).⁵ The extension of NISA could be a catalyst like the US 401K pension scheme played in the 1990s.

PM Kishida also affirmed his commitment to reform the asset management industry by easing regulations and streamlining business practices to solicit both domestic and overseas investors’ entrance.

His plan includes the creation of special business zones allowing foreign investors to complete all government applications in English. These government initiatives to attract investments to Japanese equities and investors to Japan could possibly create a virtuous cycle in terms of fund flows in the long run.

Conclusion

If these two structural changes, namely a sustained nominal GDP growth backed by the BoJ’s careful monetary policy normalization and the government reforms to enhance the entire investment chain,  ranging from corporates with room to improve capital efficiency, households with enormous potential to become investors and asset managers facing entry barriers, take place, the Japanese equity market could possibly renew the record-high of the 1989 asset bubble era.

Under this scenario, the Japanese yen is likely to rise to some extent along with the BoJ’s policy normalization, which would get rid of overseas investors’ headache as yen depreciation has wiped out most  of the local currency returns this year.

After Japan’s asset bubble burst in the early 1990s, the night has been long that never finds the day. But every night should come to an end.