February 22, 2024 (MLN): Japanese stocks reclaimed a historic peak reached more than three decades ago as investors pour money into a country that’s finally escaped deflation and is headed on a path of sustainable growth, as Bloomberg reported.

The Nikkei 225’s stellar rally over the past year caps a recovery that’s made the nation’s equities a top pick among global funds after being overlooked in favor of faster-growing markets like China.

The roller-coaster ride saw shares go from the most richly valued in the world to among the most depressed, before finding an equilibrium now in between these extremes.

The Nikkei set an all-time intraday high of 39,029 on Thursday and looked likely to pass the closing record set in 1989.

“As Japan becomes a normal country with inflation, its companies will have all kinds of potential,” said Masayuki Murata, general manager of balanced portfolio investment at Sumitomo Life Insurance.

“They appear to be stepping into a world where revenue rises even as costs climb, instead of a place where you have to continually cut spending as sales shrink.”

At its previous peak 34 years ago, the Japanese market had swelled to the point that it accounted for 37% of the world’s stocks, surpassing 29% for the US, according to the World Bank.

It was overvalued by almost any measure, as were real estate prices, inviting a collapse that took the wider economy down with them, eventually plunging the country into decades of stagnation.

Yet the tide turned. Corporate reforms promised in the early years of former prime minister Shinzo Abe’s government are now gaining traction.

Meanwhile, price hikes initially triggered by a weaker yen and rising commodity prices following the war in Ukraine have turned out to be stronger and more permanent than many had expected. That’s helping fuel a long-sought cycle of healthy inflation.

The Nikkei has soared about 16% so far this year, outstripping gains in other major markets. Strategists are becoming increasingly bullish, with some forecasting further gains of up to 15%.

Even after the rally, many Japanese stocks are still at depressed levels, with 37% of Nikkei members trading below their book value.

In theory, this means investors could make more money by selling off all the company’s assets than by keeping the business as a going concern.

This is tantamount to a vote of no confidence in management, but also suggests upside potential if companies are run right.

Only 3% of stocks in the S&P 500 trade below book value. For the Stoxx Europe 600 Index, just one-fifth fall under this category. The low valuations in Japan now are a stark contrast to 1989, when asset prices were at the other extreme.

Nikkei's valuation is moderate in the world

Source: Bloomberg, Nikkei

Yet there are still reasons to be cautious. Funds could flow rapidly back to China if global sentiment toward that market recovers, and India is rising as a rival destination for global investors.

Japan’s economy unexpectedly slid into recession in the final quarter of last year, even as the central bank continues to express optimism over wage trends that are key the nation’s continued recovery.

Meanwhile, some analysts have suggested that the Nikkei has become a momentum play, with the stocks in the index diverging from fundamentals.

For now though, the push to improve shareholder returns is continuing in Japan. Companies are being encouraged by the Tokyo Stock Exchange to publish reports on their plans to boost their equity valuations.

Some have announced share buybacks and dividend hikes. Management buyouts are on the rise and activist investors are also stepping up their campaigns.

About a third of Nikkei companies, excluding the financial sector, have a net cash position, meaning they have more cash than debt, which bolsters the cause of activist investors and the TSE. Thats around double the comparable figure for the S&P 500.

The protracted period of yen weakness, it has fallen to its lowest level in about half century on price adjusted trade-weighted terms, has also supported exporters .

Whereas in 1989 Japanese banks where the true heavyweights in the market, thanks to inflated asset prices, now things are more balanced and diverse. Key players range from Toyota Motor Corp and Sony Group Corp. to casual clothing chain operator Fast Retailing Co., and companies that hold key positions in the vast semi-conductor supply chain, such as Tokyo Electron Ltd.

“In truth, 1989 was very likely the biggest bubble in human history, dwarfing 1929,” said CLSA Securities Japan Co. strategist Nicholas Smith, referring the the US crash that helped trigger the Great Depression. “Profits have been motoring over the past decade and more, despite the deflationary drag; it’s not that profits were dawdling but rather that the peak was so lofty.”

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Posted on: 2024-02-22T11:08:53+05:00