The San Francisco-headquartered asset management house takes a quick look at the strong performance of Japanese equities, and considers what comes next and how to position for it.

The following brief commentary on Japanese equity markets comes from Shuntaro Takeuchi, portfolio manager at Matthews Asia, a US-headquartered business that specializes in making investments into the Asia region, as its name implies. These views are those of the author and not necessarily endorsed by this news service. For commentary and reaction, email tom.burroughes@wealthbriefing.com

As I gauge the outlook for Japan’s equity markets and reflect on their recent impressive performance, it is clear to me that there are many forces at work.

Firstly, Japan’s markets have benefited from a large expansion over the last 18 months. Domestic investors have flooded the market encouraged by the capital reforms that corporates have made which have yielded significant benefits for shareholders largely in the form of increased stock buybacks and dividends.

It’s worth noting that even with a record high of share buybacks by Japanese corporates last year, the total amount was still less than the value of Apple’s 2023 buybacks. On top of that, about half of Japanese listed companies are net cash. So we think that the potential for enhanced returns from buybacks and dividends will remain a force for a while though to greater and lesser degrees across sectors and industries.

Secondly, Japan has earnings' growth momentum. This is important because over the past 10 years the majority of shareholder returns have come from earnings per share (EPS) growth. This has resulted in Japan being the best performing market by US dollar returns, with the exception of India. Among popular equity allocations outside of the US, Japan’s earnings' growth isn’t closely connected to its GDP growth, which compares poorly with other developed markets. 

Instead, the financial health of Japan’s corporates is more directly tied to exports, world trade and the global economy. We think Japanese corporates are generally in good shape and the yen’s ongoing weakness to the dollar is also a macro tailwind for earnings. 

Earnings' growth momentum
From some of our recent company visits, a couple of other things are also clear. One is that inbound tourists are coming back, and in full. Tourism-related spending has surpassed the all-time high set before the pandemic and that’s without the full recovery of spending by Chinese tourists who represent the largest component. We also sense that while there’s increasing interest in Japan from global investors they are still very much under-invested in the market. So that has a long runway.

Looking ahead, we remain positive on Japan’s markets and we see the drivers that have strengthened in recent months staying strong. We would also highlight the long-term potential of Japanese small caps.

The Nikkei 225, which consists of larger cap companies, has traded at 10-year highs in terms of valuation this year while broader Japan indexes which include mid-cap to small cap companies have traded around 10-year median averages. So we believe that there is a lot of upside in the small cap and mid-cap space.

Of course, we don’t invest in large caps or small caps for the sake of their size. We always invest in companies that have superior growth over the mid to long term.

To see other examples of wealth managers' views on Japan, see here and here.