In the 1980s, Japan’s economy seemingly knew no bounds. Growth was strong, reaching a peak of 6.7 per cent in 1988 off the back of robust expansion in the 1960s and 1970s. On some measures, land in Tokyo cost four times more than the equivalent space in Manhattan.
Rules governing the banking system were liberalised in the 1980s, resulting in a sharp rise in credit flows around the economy. Much of this lending centred on the property market which, combined with relaxed monetary policy, drove land prices to exuberant highs.
Confidence in the Japanese economy continuing to grow at a rapid pace lifted investor sentiment, driving the Nikkei index of Japan’s top companies to a peak of 38,915 in the final month of the decade.
Seeing both an overheating of the economy and emerging signs of inflationary pressures, policymakers tightened monetary policy, bringing the Japanese “economic miracle” to a halt.
The country has since experienced several “lost decades” with many analysts concluding that it was impossible for the Nikkei to scale back to the peak it hit during the boom times. However, the index in 2024 has raced ahead of its peers, rising by more than 9 per cent, to touch a 34-year high of 36,546.95.
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There are similarities with the economic conditions of the 1980s. Monetary policy is exceptionally accommodative. The Bank of Japan is the only major central bank to have ignored the global inflation surge and leave interest rates unchanged, at minus 0.1 per cent.
“These low rates should continue to support domestic demand,” Daniel Hurley, Japan equity specialist at T Rowe Price, the investment management firm, said. They will also make Japanese stocks relatively attractive compared with government bonds and raise the value of company earnings.
The Bank of Japan has yet to sketch out concrete plans to wind down its yield curve control policy, in which it aims to keep the rate on the 10-year Japanese government bond, the economy’s benchmark, low by purchasing bonds with differing lengths of maturity. Although highly anticipated, Kazuo Ueda, the governor, has barely hinted at any change in strategy soon.
That the Bank of Japan has left rates in negative territory while the Federal Reserve has raised them aggressively to a range of 5.25 per cent to 5.5 per cent, a 23-year high, has substantially weakened the yen, Japan’s currency, raising demand for the country’s exports.
Analysts at Bank of America, the Wall Street investment bank, said that the yen was unlikely to gain ground against the world’s major currencies if the Bank of Japan kept financial conditions extremely loose, which would “sustain the market rally”.
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On top of this, any stock index with a heavy weighting towards technology stocks emerged as a big winner in 2023. Wall Street’s Nasdaq index is up by about 35 per cent in the past year. The FTSE 100, which is heavily exposed to “old economy” stocks such as miners and oil producers, is down by about 4 per cent for the same period.
The Nikkei hosts major manufacturers of tech hardware and software, including Sony, Mitsubishi, Hitachi and Panasonic. As a result, the index has received a leg up from “technology gains being seen elsewhere”, Richard Hunter, head of markets at Interactive Investor, said.
It is also heavily geared toward exporters, most notably car manufacturers such as Nissan, Toyota and Honda. “The US economy looks robust,” Hurley said, which, alongside a weaker yen, “should help Japan’s exporters”.
In the final months of last year, investors drastically revised down their expectations for how long the Fed and European Central Bank would keep interest rates at their peak, prompting a stock and bond market rally. However, Japanese stocks were a notable absentee from this frenzied buying.
According to Goldman Sachs analysts, “Japanese equities have been quickly making up for the underperformance over the last two months of 2023” in the first month of 2024.
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Efforts by the Japanese government to stimulate retail investor involvement in the country’s stock markets have supported the Nikkei’s gains, too. The annual investment allowance on the Nippon Investment Saving Account, Japan’s foremost retail investment vehicle, was lifted this month to $24,000. Income generated via the vehicle is eligible for an exemption from Japan’s 20 per cent capital gains tax rate.
In spite of the surge in Japanese share prices over the past 12 months, there is little evidence yet of UK private investors or their financial advisers pushing into the market, according to Russ Mould, investment director of AJ Bell. No Japan-focused investment trust makes it into the investment platform’s recent top 50 of bought funds, while the iShares Japan Equity Index tracker fund is only the 36th most popular.
However, there are reasons why some investors may be taking more of an interest. “Japan has underperformed horribly for a long time. Underperformed means unloved, and unloved can mean undervalued. Japanese equities do look attractively valued on an earnings basis, and also relative to book value, especially as a lot of that book value is cash,” Mould added.
Others point to a less supine approach to corporate governance in the country, with pro-shareholder reforms being introduced. The takeover of Toshiba last year has been seized upon as evidence of a change in culture, more openness to mergers and acquisitions and less tolerance of poor management over a sustained period.
● David Brenchley: Land of the rising stock market
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Three decades ago, the Japanese bubble was burst by central bankers bearing down on inflation. The 30 years since have been characterised by stubborn deflation, prompting the Bank of Japan to implement unconventional policy measures to boost demand.
Finally, after years of dormancy, inflation returned to the Japanese economy in 2022 and 2023, peaking at more than 4 per cent, a four-decade high. But the Bank of Japan stood still in contrast with the world’s other foremost central banks, possibly for fear of repeating the pitiful economic performance experienced during the 1990s. The Nikkei, for the time being, is the main beneficiary of that anxiety.
How private investors can gain exposure to Japan
The days when Japan was considered a substantial and crucial component of any UK investor’s portfolio are long gone (Patrick Hosking writes). Back in the 1980s, the UK fund management industry created numerous specialist funds to harness what was then regarded as the world’s unignorable miracle economy.
But the bubble burst in 1989 and investors who held on saw a sliding market for the next 19 years. Today Japan accounts for just 6 per cent of global stock market weightings, down from a high of 40 per cent, so it is likely to be a very small component in most people’s pension savings pots now.
There are, however, still plenty of ways for private investors to get exposure to Japan, with the cheapest being an exchange traded fund that tries to replicate one of the main stock market indices in the country.
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The iShares MSCI Japan fund run by BlackRock tracks the 225 Japanese listed companies in the Japan index compiled by MSCI and has plenty of familiar names. Its two biggest investments are Toyota and Sony. It is also relatively cheap, with a total expense ratio of 0.12 per cent.
Analysts say beware of tracker funds that try to replicate the Nikkei 225, Tokyo’s most familiar index, because it is price-weighted, a questionable methodology which means that it is disproportionately influenced by companies with high share prices.
Another Japan tracker is the Vanguard FTSE Japan Ucits ETF, which tries to replicate a different index of Japanese stocks reflected in the FTSE Japan index. This is more broadly based with 511 stocks. It quotes an ongoing charge figure of 0.15 per cent.
For investors who want their investments managed by active stockpickers, a number of Japan-focused investment trusts remain, including those managed by Schroders, JP Morgan and Fidelity.
The best-performing Japan-focused investment trust over the past 12 months and the past five years is CC Japan Income & Growth Trust, a £240 million trust which over the latter period has produced a 43.6 per cent share price total return. It favours companies likely to do well from corporate governance reforms and is not afraid to take big bets on smaller companies.
Baillie Gifford Japan Trust is one of the biggest, weighing in at £640 million, but has been one of the worst-performing in recent years because of its favouring of tech stocks in the country. Its biggest single investment is SoftBank, the tech investment house. Unloved, it trades at a 10 per cent discount to net assets.
Among unquoted funds, Jupiter Japan Income Fund is well-regarded by some. A fund of more than £1 billion, it is fairly concentrated with 38 holdings with large exposures to financial and consumer stocks as well as industrials and technology. Over ten years it has produced a 145.3 per cent return, as against 113.1 for the Topix index. The ongoing charge number is 0.98 per cent.
One tip for any overseas-based Japan investor is that the share market often moves inversely with the currency in the shorter term. After translation back into sterling, the gains from a bull market can be less exciting, but the losses from a bear phase may be less painful.
