The ongoing bull run in the Japanese equity markets

After a prolonged period of anticipation, Japan’s stock market has finally surpassed the peaks last seen in 1989, marking a new era for investors who have patiently waited for 34 years. This remarkable milestone is not just a reflection of passing market sentiment but signals a deeper transformation within the Japanese corporate sector that could spell a new chapter for global investors.

The resurgence in the Japanese stock market can largely be attributed to a confluence of factors that have gradually aligned to create an attractive investment environment. The country’s exit from deflation, as officially announced by the Bank of Japan, and the shift in corporate governance have been pivotal. These elements, combined with the most substantial net foreign inflows since 2014, have set the stage for what could be a sustained bull market.

Structural changes driving market confidence

The narrative surrounding Japan's stock market rally has been less about fleeting market trends and more about substantial structural changes at the corporate level. For years, Japan’s companies were criticized for their lack of focus on profitability and shareholder value. However, recent years have witnessed a significant shift as these companies adopt more aggressive strategies towards profitability and efficiency, driven by internal changes and external pressures from engaged investors.

This shift is crucial as it represents a departure from the historically conservative corporate practices that have long defined Japanese firms. The change is not merely superficial; it involves deep-seated reforms in corporate governance that encourage transparency, shareholder engagement, and strategic management practices that prioritize long-term growth over short-term gains.

Economic indicators and market performance

The Nikkei 225’s performance has been a strong indicator of this newfound investor confidence, posting gains of more than 28% in 2023 alone. This growth is underpinned by an improving economic landscape, with Japan signaling the end of its deflationary period and embarking on a path to sustainable economic recovery.

Moreover, the valuation metrics of Japanese equities suggest that despite the recent rally, there is still considerable room for growth in our view. Compared to their global counterparts, Japanese stocks are relatively undervalued, which presents a compelling case for both domestic and international investors. For instance, nearly half of the companies listed in Japan have a price-to-earnings ratio of less than 15, a stark contrast to the U.S., where the figure is only 13% and such undervaluation is far less common.

The broader implications for global investors

The Japanese market's evolution is particularly significant for global investors seeking diversification and potential growth outside the more saturated Western markets. The unique combination of improved corporate governance, favorable economic policies, and attractive valuations may provide a potent mix for those looking to invest in a market that combines stability with growth potential.

As we look forward, the market is likely to see a broadening of investor focus. Initially concentrated on large-cap stocks and specific metrics like the price-to-book ratio, investment trends are expected to diversify across different sectors and company sizes. This shift will likely open up new opportunities for stock pickers and investors looking to capitalize on less explored segments of the market.

A new era in Japanese investing

The transformation of Japan’s equity market is a narrative of patience and perseverance. It’s a story about a market that has slowly transformed itself from the inside out to emerge as a beacon of potential in a complex global investment landscape. For investors willing to engage with the market’s nuances, the ongoing structural reforms and the macroeconomic stability promise a rewarding journey ahead.

The sustained growth and structural changes within the Japanese corporate sector are not just a boon for local investors but for the global investment community, offering a promising horizon in an otherwise uncertain world.

*This article was first published, in Chinese, in the Hong Kong Economic Journal.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance.