Is it time for investors to make it big in Japan again?

Undervalued stocks and a weak yen could make it the opportune moment to increase exposure to the country

The Nikkei has held relatively steady amid 2022’s troubles, falling only 3.84 per cent in the year to date. AP

Japan may have the world’s third-biggest economy after the US and China, but it’s a country that many international investors unfairly overlook.

In this troubled year, its stock market has been an oasis of relative calm and stability, dipping only slightly when others have crashed. So, is it time to go big on Japan, again?

Investors have shunned the country’s stock markets since the glory days of the 1980s, when everyone said Japan was the future and the Nikkei 225 flew to a high of 38,915 on December 29, 1989.

Three “lost decades” followed after the bubble burst and Japan slumped into a low growth, low interest rate economy, with an ageing, shrinking population.

Japan looked like the future again, but this time in the wrong way, as the rest of the developing world followed its lead by shrinking and ageing, too.

The shocking assassination in July of former prime minister Shinzo Abe, who had battled to overhaul the Japanese economy with his “Abenomics” reforms, left the country in shock and wondering where it goes next.

Yet Japan still boasts an enviable array of powerful global brands, especially in cars and electronics, with notable names including Toyota, Honda, Mitsubishi, Canon, Sony, Panasonic, PlayStation, SoftBank and Uniqlo.

The Nikkei index is still way below its record high, trading at 28,176 at the time of writing, but it has held relatively steady amid 2022’s troubles, falling just 3.84 per cent so far this year.

Measured over five years, the Nikkei is up an impressive 44.71 per cent, a strong return for loyal, long-term investors.

Japan's stock market has received an added boost from the weakness of the Japanese yen, says Alex Harvey, senior portfolio manager and investment strategist at fund manager MGIM.

The yen has plunged to a 24-year low against the US dollar, after falling 15.66 per cent so far this year, but there’s a bright side.

“Japan’s economy is built on a large exporting base and the yen’s weakness makes these exports relatively cheaper to buyers in other currencies,” Mr Harvey adds.

Sentiment towards Japan is now improving. In May, Nikko Asset Management said global investors have spent years chasing the next big thing, while Japan has quietly been undergoing a transformation that has left it offering hidden value as stock market reforms bear fruit and companies deliver vastly improved profit margins.

Mr Abe’s “three arrows” reforms policy is being pursued by his successors, according to John Vail, Nikko’s chief global strategist.

“The arrows are higher government spending, more accommodative monetary policy and a package of structural reforms to raise economic growth and shake the Japanese economy from its slumber,” Mr Vail says.

Since Prime Minister Fumio Kishida took office in November 2021, his government has worked closely with the Bank of Japan to achieve 2 per cent inflation and sustainable growth.

“The bank’s purchases of Japanese government bonds and exchange-traded funds [ETFs] since 2013 have helped lower the yen, support export-driven companies and boosted Japanese stock prices,” Mr Vail says.

Monetary policy is expected to remain accommodative, creating a constructive environment for Japanese companies, he adds.

Yet, the role of the yen in Japan’s continuing export success can be overstated as companies such as Toyota ramp up overseas production capacity.

“While a weaker yen is generally positive, it is much less of an influence on whether to invest in Japanese companies.”

Japan has a unique role as a bridge between the East and the West, and developed and emerging markets, Mr Vail says.

Its stock market represents 8 per cent of the MSCI World Index, and it is the fourth-largest global exporter after China, the US and Germany.

Almost 59 per cent of Japanese exports are within the Asia Pacific region, led by China, South Korea, Chinese Taipei and Hong Kong, compared with 25 per cent to the Americas and 16 per cent to Europe, Africa and elsewhere, Mr Vail says.

“This means Japan is reaping the benefit of emerging market growth trends, while not necessarily being exposed to the same risks,” he adds.

Japan is now enjoying a boost as its number one trading partner China eases Covid-19 restrictions, Dina Ting, global head of index portfolio management at fund manager Franklin Templeton, says.

“This should offer tailwinds from significant pent-up demand, while Japan also boasts one of the highest Covid-19 vaccination rates among G7 nations at around 82 per cent.”

The cheap yen will trigger a rebound in tourism as Japan eases pandemic border restrictions.

“Japanese equities are undervalued relative to many other developed nations and we believe its market is worth a closer look as a slice of investor portfolios,” she says.

Abenomics is steadily bringing Japan’s corporate governance into line with global standards, Ms Ting says. But she cautions that change can be sluggish in Japan and more is needed.

“His successors continued to nudge such reforms along and have twice revised Japan’s Corporate Governance Code to better promote diversity, especially for women in leadership roles.”

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Yet it has stopped short of setting any specific targets and Japanese women continue to lag behind the global average, Ms Ting adds.

“We are encouraged by Japan’s recent efforts to expand immigration policies for foreign workers towards solving labour issues.”

It took Japan almost a decade to hit the 2 per cent inflation target set in 2013, and the country only got there this year due to the energy price shock.

“However, this may finally help psychologically jolt consumers from their long-held deflationary mindset,” Ms Ting says.

The near-term outlook for its stocks is one of cautious optimism, she says, as Japanese equities fare notably better than developed market peers.

Mr Abe’s legacy has boosted shareholder returns, with dividends up and Japanese companies planning to double stock buybacks to a 16-year high of around $32 billion this year, which will bolster market confidence, Ms Ting adds.

Global supply chain constraints and higher raw materials costs weighed on Japanese exports, and demand is falling as the West slips closer to recession.

Demographics remain a worry, with Japan’s population projected to fall from 127.09 million in 2015 to around 110.92 million by 2040 and 88.08 million by 2065.

Yet the International Monetary Fund has called Japan a “laboratory from which other countries are beginning to draw lessons”, Ms Ting says, as it responds by developing artificial intelligence, automation and robotics.

“Despite global supply hurdles, pandemic-induced demand for integrated robotics has spiked over the past two years.”

Japan consistently ranks highly on the World Economic Forum’s Global Competitiveness Index and is a leader in global patent activity, while Tokyo is now strengthening its start-up ecosystem.

This should foster entrepreneurship and revitalise the economy, she adds.

“Even in this infamously greying society, there are silver linings for its economy and for investors wanting to increase exposure to Japan at this time.”

Investors may now want to go big on Japan, but they should include some exposure in their portfolio, using yen weakness as an opportunity.

The simplest and cheapest way is to invest in a low-cost ETF, with the most popular ones including iShares MSCI Japan ETF, Franklin FTSE Japan ETF, JPMorgan BetaBuilders Japan ETF, Xtrackers MSCI Japan Hedged Equity ETF and WisdomTree Japan SmallCap Dividend ETF.