Weekly Buzz: 🌸 Blossom season came early for Japanese stocks

19 January 2024

Amid a broader decline across Asia, Japan’s major stock index, the Nikkei 225, has defied the trend. It broke a 33-year-old record last week, surging past the 35,000 mark for the first time since February 1990 – Pokémon didn’t even exist back then.

What’s driving this rally?

China still hasn’t recovered its balance after being knocked off-course during the pandemic. But investors didn’t need to look far to find a promising replacement in Japan. A dual revival in growth and inflation, paired with a series of corporate reforms, have revived foreign investor interest in the country’s equity markets.

Improvements in corporate governance have been a key driver – though they don’t make for very flashy headlines. Japanese companies have been known to hoard cash since the country’s economic crash in the 1990s. But over the past decade, corporate reforms have resulted in steadily increasing stock buybacks and dividends from Japanese firms.

Inflation is welcome in Japan

Plus, Japan seems poised to break its streak of deflation (our Simple Finance section below breaks this down). After twenty years of ever-shrinking prices, Japanese shoppers have almost been programmed to hold back on purchases. If the country’s newfound inflation sticks around though, they’ll warm up to spending more again.

That’s been another contributor to this rally – the more money floats around the economy, the more likely Japanese companies can perform. As opposed to the rest of the world, the Bank of Japan (BOJ) has kept its monetary policy loose, in an effort to actually encourage inflation. 

While the economic picture for Japan is looking rather pretty, it may not be all sunshine and flowers. The US Federal Reserve (the Fed) and the BOJ might both start normalising monetary policy this year – with the former expected to cut interest rates, and the latter seen to raise rates out of negative territory. Combined, these forces could mean a stronger yen, which could lead to less support for Japanese exports.

As an investor, what does this mean for me?

Taking everything into account, Japanese stocks do look attractive. But yen appreciation could result in less pronounced equity returns, compared to 2023’s large gains.

The best way to benefit from any rally: stay invested in a diversified portfolio; it’s tough to miss out that way. Keeping your portfolio diversified allows you to navigate through shifting economic seasons, and ensures you're well-positioned to reap the benefits of global market fluctuations, including Japan's current financial spring.

For diversified exposure to regions around the world, including Asia, consider our General Investing portfolios. And for more, well, flexibility, our Flexible portfolios can help you tailor your exposure to specific countries, like Japan.

💡 Investors’ Corner: Why small could be mighty

Sometimes the small can be mighty. But that wasn’t the case for stocks in 2023. US small-cap stocks, represented by the Russell 2000 index, returned 15% last year, less than the 23% returned by their larger cousins in the S&P 500.

Small-cap shares were hit harder by the combination of interest rate hikes, recession worries, and an AI boom that fueled the rally for the huge-cap Magnificent Seven.

But the big picture is likely to turn in favour of the Russell 2000 companies, because these firms have a higher proportion of floating rate debt compared to their S&P 500 counterparts. And sure, that means they’ve suffered more damage from the impact of rising interest rates, but with the Fed likely to cut rates in the future, they’ll be paying less for their debts then.

Plus, small-caps look good on a valuation basis, trading at almost 20% below their long-term average, while their heftier counterparts are cruising at up to 20% above their usual. This difference is wide right now, and history tells us we’re probably headed for a turnaround.

But before you dive into the small-cap pool, here’s a heads-up: about 40% of the Russell 2000’s companies didn’t make a profit last year. So, you’re going to need to look for stocks with quality earnings. A better alternative is simply to invest in a diversified portfolio that already includes some exposure to these smaller companies.

These articles were written in collaboration with Finimize.

🎓Simply Finance: Deflation

Deflation is, basically, the opposite of inflation. It's when the prices of goods and services fall across the economy. Now, this might sound like good news at first, because things become cheaper, but deflation often signals a weakening economy. When prices drop, businesses earn less, leading them to cut costs by reducing wages or even laying off employees. Consumers, anticipating further price drops, might delay purchases, which further slows down the economy.

Deflation can trigger a challenging cycle, where declining prices cause a slowdown in economic activity. Japan faced this problem after its economic bubble burst in the 1990s, leading to what is now known as the Lost Decades.

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