Japan's stock market crashes – what it means for investors

Japanese prime minister Fumio Kishida has given up. Beset by public anger about cost-of-living pressures and a party corruption scandal, Kishida has announced that he will not seek re-election as leader of the country’s governing party. He is expected to step down next month. Change at the top of Japanese politics comes as the local stock market recovers from a bruising sell-off, which saw the Nikkei fall 12.4%, its biggest one-day drop since 1987. 

Japanese shares suffered their worst two-day drop since the 1950s, says River Akira Davis in The New York Times. The plunge could mark the end of one of the country’s “most enduring stock rallies” in decades. The benchmark Topix index has gained 36% since the start of last year amid excitement about corporate reform. Yet the speed of the drawdown – which came after the yen strengthened – has left many asking if Japan’s much-vaunted revival was just an illusion driven by currency weakness. The weak yen boosts the earnings of big listed multinationals, such as Toyota. 

The Topix has rallied 15% from its nadir last week, although it is still down 11% since the mid-July peak. Such “absurd” daily swings make Japan resemble an emerging market, says Leo Lewis in the Financial Times. In just a week, the Topix “drunkenly” lurched from being “one of the best-performing major benchmarks of 2024 to one of the worst”. The “whole market is trading like a penny stock”, laments one fund manager. While there have been some “genuine bright spots”, sceptics say that the sell-off has “exposed the true face of an economy” that is still rife with “zombie” businesses, bad management and wasted capital. “Far too many companies” in Tokyo “should not be listed at all.”

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Should you buy Japanese equities?

A 20.3% stock plunge over three days marks Japan’s worst performance in data going back to 1973, says Jeff Weniger of WisdomTree. But the crash might spell opportunity. After previous big drops in Japan, the median subsequent 12-month return was 10.9% and the average was 14.6%. The $1.1 trillion drawdown in Tokyo has wiped “some of the froth” off a market that was becoming overheated, say Hideyuki Sano and Aya Wagatsuma on Bloomberg. Valuations look reasonable again, with the Topix on a forecast 13 times earnings, compared with 20 times for America’s S&P 500. The sell-off was triggered by a rate hike from Japan’s central bank, but the bankers – scared by the market’s fragility – now say that they won’t tighten too quickly, cutting the risk of a repeat performance. 

The era of a weak yen propelling banks, insurers, carmakers and tech to the forefront of the Topix is drawing to a close, says James Salter of Zennor Japan Fund. These trades unwound quickly last week after becoming “overcrowded” with foreign cash. “It will take a little time for the market to adjust,” but a stronger yen doesn’t kill the case for Japanese equities. Instead, the baton will now pass to smaller, more domestically oriented stocks that are enjoying the fruits of a “corporate governance revolution”. For investors, the Tokyo crash could ultimately mean “lower prices and better valuations”.

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