While a consensus that a country's stock market has more room to rise can give investors cause for being queasy, there appears no let-up in the chorus of praise for how Japan has unleashed a much more vigorous equity sector.

Japanese equities have rallied as post-pandemic changes to global supply chains have put the Asian country’s manufacturing prowess under the limelight, and the long-term fruits of reforms to the way firms unlock shareholder value are also coming through.

And, as far as wealth managers are concerned, the story is far from over.

The Nikkei 225 Index of major Japanese firms’ shares is up 15.2 per cent since the start of this year, and up 23.4 per cent over the past 12 months (source: Royal Bank of Canada). Over two years, it is up 44 per cent, beating every other major index, with the Nasdaq in second place over two years, at 39.5 per cent, and India’s Sensex in third, at 35.7 per cent. Another measure of Japanese equities, the TOPIX Index, is up 44.8 per cent over two years.

“The recent surge in the Japanese equity market is driven by improved economic prospects, global supply chain shifts, enhanced retail investment incentives, high-profile investments, and significant corporate governance reforms,” Redmond Wong, chief China strategist for Saxo Markets, part of Denmark’s Saxo Bank, said in a note. “Share buybacks have increased, reflecting a shift towards more shareholder-friendly practices. Despite the market's rise, numerous undervalued investment opportunities remain, particularly among companies trading below book value and deep-value net-net stocks. These factors make the Japanese market attractive for value-oriented investors who may wish to conduct further research on potential investment opportunities.”

And Wong reckons that reforms, aimed at making firms more efficient and passing back more cash to shareholders, haven’t yet run their course.

“Despite the significant rise in the TOPIX index, a substantial number of Japanese companies still trade below book value. Out of the 2,141 companies in the TOPIX index, 1,016 (47 per cent) have a price-to-book ratio below 1. Notably, 203 of these companies have more cash than current liabilities, and 108 of these have cash exceeding total liabilities,” Wong said. “This situation highlights Japanese companies with strong balance sheets and the potential for share buybacks or dividend increases. For comparison, in the S&P 500, only 17 companies or 3 per cent of the index constituent stocks trade below a 1x price-to-book ratio, and none has more cash than current liabilities.”

The story of how Japan managed to revive its economy after many decades of stagnation has been one of the bright points for investors. This publication has interviewed a number of wealth managers about what they think about Japan and the best ways to play into the narrative. (See examples here, here and here.)

Yutaka Uda and Maiko Uda, portfolio managers, Nippon Growth (UCITS) Fund, Eric Sturdza Investments, agree that a big shift is under way in Japan. 

“Japan is on a sustainable growth trajectory and is set to experience significant economic expansion and rising corporate profits. We anticipate Japan’s gross domestic product to grow by 2 per cent per year in real terms, and by 4 per cent in nominal terms between 2023 and 2025,” they said. 

They see further gains for equities. 

“Japanese stocks are recording their strongest gains in a decade, and we expect the Nikkei 225 and TOPIX to continue to gain. The TOPIX recorded a March high of more than 2,800 points, and year-to-date gains of around 15 per cent. As the economy expands, we expect Japan’s stock market to keep rising and reach a record 3,000 points by the end of 2025,” they said. 

One fly in the ointment has been the weakness of the Japanese yen, but the managers said they expect it to strengthen. 

“Despite interventions, the Japanese yen remains at its lowest level against the dollar in more than five decades. We predict that interest rate tightening over the next two years should support the Japanese currency to a more reasonable level of around 120 to 130 yen to the dollar,” they said. “While this adjustment may challenge Japanese exporters, domestic-focused sectors like retail and construction would benefit significantly from the yen’s appreciation. Although short-term fluctuations are possible, a gradual strengthening of the yen should positively impact the Japanese economy and markets over the medium term.”

The BlackRock Investment Institute, part of BlackRock, recently issued an upbeat note about Japan.

“We remain tactically overweight Japanese equities on bright fundamentals and the relatively benign macro backdrop. On a longer horizon, we see the mega forces at play creating compelling sectoral opportunities in Japan that augur well for a more active investment approach than in the past. We favour an above-benchmark allocation to Japan over a strategic horizon (for professional investors),” it said. 

The organisation continued: “The latest Development Bank of Japan (DBJ) survey of major Japanese firms pointed to a second consecutive increase in planned domestic capital spending for the fiscal year ending 2023 of 20.7 per cent, surpassing the pre-pandemic levels. These spending plans lean towards digitisation (particularly in decarbonisation initiatives and railways), semiconductors supply chain and electric vehicles according to the survey, reflecting how a capital spending revival intertwines with mega forces.

“These spending plans reflect how Japan – like other countries – is not alone in looking to strengthen control over supply chains and insulate from risks of geopolitical fragmentation. Subsidies for domestic chip foundry ventures reflect Japan’s push to rebuild the country's chip manufacturing base though it has a way to go to catch up with regional players like South Korea and Taiwan,” it concluded.