The Nikkei 225 hit a record high of 38,916 points in December 1989 during the peak of Japan’s asset bubble, but never recovered as rallies fizzled. Last month, the index topped the 33,000 level for the first time since 1990 and remains in that range.ISSEI KATO/Reuters
Sign up for the Globe Advisor weekly newsletter for professional financial advisors on our newsletter sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know. For more from Globe Advisor, visit our homepage.
Japanese stocks are having a moment, helped by shareholder-friendly reforms, a weak yen, and foreign fund flows amid an endorsement by legendary U.S. investor Warren Buffett.
The blue-chip Nikkei 255 Index has risen 28 per cent this year, while the broader Tokyo Price Index, or Topix, is up 23 per cent. They have outpaced the S&P 500 Index’s 16-per-cent gain.
“We are very bullish, and have been positioned for a Japanese bull market since December 2021,” says Tyler Mordy, chief executive officer and chief investment officer at Kelowna, B.C.-based Forstrong Global Asset Management Inc.
“In one of our global mandates, Japan is a 15-per-cent weighting [versus 6.3 per cent for the MSCI World Index],” says Mr. Mordy, whose firm runs portfolios using exchange-traded funds (ETFs).
The Nikkei 225 hit a record high of 38,916 points in December 1989 during the peak of Japan’s asset bubble, but never recovered as rallies fizzled. Last month, the index topped the 33,000 level for the first time since 1990 and remains in that range.
Mr. Mordy says he believes the Japanese rally “is really different this time” even though many portfolio managers have been burned by bottom fishing for stocks in the world’s third-largest economy.
Japan has gained more investor attention since Mr. Buffett’s Berkshire Hathaway Inc. bought stakes in Japan’s five top trading houses in 2020 and upped its interest last month to an average of more than 8.5 per cent.
“If one of the world’s best value investors sees value in Japan, maybe others should as well [is probably the thinking],” he says.
Governance reforms, dividends and buybacks
A big catalyst for a bull market is the corporate governance reforms that began a decade ago under former prime minister Shinzo Abe, and are now “starting to unlock shareholder value,” Mr. Mordy says.
Corporate Japan has been under pressure to sell cross-shareholdings. It’s a practice whereby listed firms will own stakes in each other to cement business relationships versus getting a return on investment.
However, it’s the Tokyo Stock Exchange’s new rule requiring companies trading below book value to give detailed plans to improve their valuations that is “pretty impressive,” he says.
On July 3, the exchange also launched the JPX Prime 150 Index aimed at making visible leading Japanese companies estimated to create value.
Over the decade from 2012 to 2022, dividends and buybacks have doubled, and more will happen as the “bull market unfolds,” he adds.
Japanese stocks can also benefit as a proxy play on China’s recovery which has been sluggish, he says.
“China is Japan’s largest trading partner, so any upside surprises in Chinese growth benefits Japan,” he adds.
Japan’s institutional investors, who steadily reduced domestic stock holdings in favour of bonds after the market collapse, are also expected to take on more equity exposure amid attractive valuations and rising inflation, while foreign-capital repatriation is happening now, he says.
On a macro-economic level, Japan has been stuck in a deflationary spiral for decades, but headline inflation reached 4.3 per cent in January – the highest in 42 years although it has eased a bit since then, he says.
“We view that its [ultra-loose] monetary policy will be normalized very gradually,” he adds. “The undervalued yen, and our view on longer-term foreign-exchange appreciation are tailwinds for keeping Japanese equities unhedged.”
Forstrong is playing the Japanese market through the large-cap-oriented JPMorgan BetaBuilders Japan ETF BBJP-A, and WisdomTree Japan SmallCap Dividend Fund DFJ-A.
Market can surpass 1989 record high
Amber Sinha, senior portfolio manager of global equities at CIBC Asset Management Inc. in Toronto, is also upbeat on the Japanese market.
After falling behind in past decades, Japan is just beginning to modernize its economy to become a technology leader vis-à-vis South Korea, Taiwan, and China, says Mr. Sinha, who oversees the CIBC Asia Pacific Fund. “It is that transformation that makes us more positive.”
Although higher inflation and interest rates are headwinds for almost all economies globally, they would benefit Japan because it has struggled with deflation for so long and has had a highly ineffective, zero-interest rate policy in responding to it, he says.
It looks like the Japanese market can surpass its 1989 record high, he adds.
“When transformational changes happen, you tend to benefit for longer periods of time than the three or six months that we have seen,” he says.
Still, Canadian investors need to keep in mind that the yen is a “wild card” that can impact returns when converted back into dollars, he says.
With the weak yen, “you can knock off about 15 per cent from local returns,” he says. For example, if the Japanese market is up 27 per cent, it would be about 12 per cent in Canadian dollars.
Mr. Sinha is bullish on the industrial technology space. He likes Keyence Corp. KYCCF, which makes industrial automation and inspection equipment and is one of Japan’s largest companies.
He has increased exposure to Japanese banks that will benefit from rising interest rates in the future. They include Sumitomo Mitsui Financial Group Inc. SMFG-N, which plans to reduce its cross-shareholdings over time.
Bicycle parts maker Shimano Inc. SMNNY is also a compelling play, partly because it has 60 to 70 per cent of the market globally and is a big player in the electric-bike industry, he adds.
‘False dawns’ in land of the rising sun
Martin Cobb, a Toronto-based senior vice-president of equities at Lorne Steinberg Wealth Management Inc., is getting “a bit cautious” by a rally that foreign investors have largely driven.
“A lot of the hope for change in corporate governance has started to bake themselves into share prices,” says Mr. Cobb, who co-manages the Steinberg Global Value Equity Fund.
“There are pockets that are overbought,” he says. “We own some stocks that are quite international but happen to be based in Japan. The weaker currency means that their earnings are benefiting.”
His global equity fund has a 7.5 per cent weighting in Japanese stocks – modestly overweight the MSCI World Index.
He likes Yamaha Corp. ADR YAMCY, which makes musical instruments and audio equipment and has three-quarters of its sales outside of Japan. It has been reducing its share-crossholdings, has net cash on its balance sheet and has started buying back shares, he says.
Mr. Cobb also favours Kirin Holdings Co. Ltd. ADR KNBWY, Japan’s second-largest brewer. It also has cross-shareholdings in pharmaceutical firm Kyowa Kirin Ltd. and cosmetics company Fancl Corp.
Kirin is a solid predictable business, and “if it were to monetize those stakes, it would be icing on the cake,” he adds.
His fund also owns ESPEC Corp., a maker of environmental test chambers for electronic devices such as cell phones. This small-cap company has net cash on its balance sheet and is buying back shares.
Mr. Cobb, who began investing in Japan at his first job in 1992, says he has seen many “false dawns” in the land of the rising sun.
The Japanese rally has “a little bit more meat to it this time,” but less impressive when converting back to U.S. or Canadian dollars, he notes.
The country still faces challenges from its high debt level, while an aging population that needs to save can prevent Japan from really becoming a consumer-spending economy, he says.
“I think foreigners are going to dictate where the market is going to go in the short term.”
For more from Globe Advisor, visit our homepage.