Japanese stocks have been on an incredible rally over the past couple weeks, with the Nikkei 225 surging to levels not seen since the peak of the country’s asset bubble in 1990. As of Tuesday, the Nikkei closed at 36,932, its highest finish since February 20, 1990 when the index peaked at 38,957.44 before crashing spectacularly later that year.
Strong Corporate Earnings and Weak Yen Fuel Gains
The recent gains have largely been fueled by strong quarterly earnings reports from major Japanese corporations, as well as the weakening of the yen against the US dollar boosting exporter profits.
Toyota Motor Corp and Sony Group Corp both raised their profit forecasts for the full fiscal year last week after reporting better-than-expected earnings in the October-December quarter. According to Toyota, it now expects full-year operating profit to reach 4.5 trillion yen ($34 billion), while Sony raised its forecast by 30 billion yen to 1.16 trillion yen.
Several other large manufacturers and tech companies also posted strong earnings, lending support to the broader market. Analysts say Japanese corporate earnings overall are likely to keep rising this year as companies pass on higher costs to consumers and the weak yen makes products more competitive overseas.
The yen has dramatically declined from about 115 yen to the dollar a year ago to 132 yen currently. This filters through to higher repatriated profits for exporters like Toyota and Sony when overseas sales are converted back into yen. These currency moves alone could add over 5 trillion yen ($38 billion) to total corporate earnings this year if sustained, analysts estimate.
| Company | Q3 Operating Profit (yen) | Forecast for Full Year (yen) |
|---|---|---|
| Toyota | 1.08 trillion | 4.5 trillion |
| Sony | 465 billion | 1.16 trillion |
“The outlook for further yen depreciation and global economic recovery underpins Japanese equities,” said Takashi Hiroki, chief strategist at Monex Securities. “Expectations that Japanese companies’ earnings will remain strong are supporting market sentiment.”
Investor Rotation into Value Stocks
Another factor behind the Nikkei’s surge is rotation by investors out of expensive growth stocks into cheaper value stocks, which have more exposure to the economic cycle.
“We’ve seen a lot of switching out of growth and defensive stocks over the past couple months into value stocks that benefit from the economic recovery and higher yields,” said Will Sutcliffe, portfolio manager at Kimura Capital.
This rotation is being driven partly by rising bond yields, which lower the relative valuation of high growth tech stocks. The yield on the benchmark 10-year Japanese government bond recently touched 0.5% for the first time since the Bank of Japan adopted its yield curve control policy in 2016.
While the rise in yields has been modest by global standards, it indicates growing speculation that the central bank could adjust its ultra-easy monetary policy settings this year given rising inflationary pressures.
Higher yielding value sectors like financials and industrials have outperformed during the recent rally, with shares of major banks like Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group surging around 20% over the past month. Auto stocks like Toyota and Honda have also posted double-digit percentage gains.
“Banks and other value stocks still have some catching up to do and more upside if Japan’s economy keeps recovering,” Sutcliffe said.
Historic Breakouts Across Japanese Stock Market
Alongside the stellar rise of the Nikkei 225, Japan’s other major stock indexes have also been hitting major milestones.
The Topix, which covers the largest companies listed in Tokyo, earlier this month reached its highest levels since September 1991. The index has gained around 7% so far in 2023 after finishing last year with a 6% rise.
The breakout beyond the early 1990s peaks is psychologically important, analysts say, leading to increased bullish sentiment among local retail investors.
“Japanese retail investors are quite sensitive to key technical levels, so seeing indexes like the Nikkei and Topix at multi-decade highs generates excitement and fuels further buying,” said Naoki Murakami, chief investment officer at Duo Asset Management.
The market rally has also flowed through to smaller cap stocks, with the Mothers Index of startups and growth companies surging to its highest since February 2000 and the Jasdaq index of over-the-counter stocks hitting levels not seen since July 2021.
Monetary Policy Shift on Horizon
Looking ahead, analysts say Japanese shares still have room to extend gains this year if the economic recovery continues and corporate profits remain resilient. However, the pace of increases could start to slow by the second half of 2023.
Much focus is centered on when the Bank of Japan could start moving away from its ultra-stimulatory monetary policies of negative interest rates and extensive bond buying to keep yields low. Such a shift would likely trigger some volatility and lead to yen appreciation, eroding exporter earnings.
Current BOJ Governor Haruhiko Kuroda will step down in April with two new deputy governors also set to be appointed around that time. Most economists predict policy adjustments will happen later this year after the leadership transition.
“The Bank of Japan will likely keep policy very accommodative at least through the first half of 2023. But we think by the September meeting it will make some incremental tweaks like allowing 10-year yields to rise further,” said Naoki Iizuka, senior economist at Marusan Securities. “This will be the beginning of policy normalization.”
Any signaling of higher rates in Japan typically causes an adjustment in equities markets, so that presents some risk of a correction. However, brokers say dips would be viewed as buying opportunities given the positive economic backdrop.
Historic Peak Within Reach
While Japanese stocks still have some hurdles to overcome, strategists say the old all-time high from 1990 of around 39,000 points on the Nikkei 225 is within reach either later this year or in 2024.
From current levels, that represents only another 6% of gains. If deflationary pressures and bond yields continue creeping higher alongside economic expansion, analysts see no reason the Nikkei cannot retest these levels over the medium term.
“I think the Nikkei rallying to around 39,000 by early 2024 is definitely achievable based on valuations and the supportive fundamental environment,” said Takashi Nakamura, chief strategist at Daiwa Securities.
Some forecasts are even more bullish. Shingo Ide, chief equity strategist at the NLI Research Institute, recently revised his year-end 2023 target for the Nikkei 225 up to 42,000 – which would surpass the 1989 peak.
While risks around global recession and potential shocks from Chinese reopening remain, the consensus view is that Japanese stocks still have upside from current levels as the reflation trend continues.
“The market is supported by expectations for the end of deflation and a weaker yen boosting corporate profits,” Ide said in a research note. “We cannot rule out a near-term correction, but the medium-term uptrend looks solid.”
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