Why now is a great time to buy Japanese stocks

Last Friday, Japanese prime minister Yoshide Suga resigned, saying he would not seek re-election after spending just one year in office.

His term, which is due to finish at the end of this month, was marred by rising Covid-19 infections and a spate of poor policy decisions.

While it is unclear who will succeed him, the Japanese stockmarket has welcomed his departure, hitting a 30-year high. The country’s wider TOPIX Index hit its highest level since April 1991, while the Nikkei jumped to its highest level since April this year.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

There are a number of possible successors with Fumio Kishida, the former foreign minister; Sanae Takaichi, the former minister of internal affairs and telecommunications; and vaccine minister Taro Kono all popular choices.

But the outspoken Kono appears to be the front-runner and is leading in many polls, according to media reports.

So does this usher in a new era of growth in Japan’s stockmarket?

For Shoji Hirakawa, chief global strategist at Tokai Tokyo Research, Suga’s departure has reduced the chances of the ruling Liberal Democratic Party losing in the next election:

“With Suga not running in the LDP leadership election, there’s less chance of the LDP losing badly in the upcoming general election -- that will give support to the stockmarket.”

As Daniel Madden, chief market analyst at Equiti Capital, tells MoneyWeek, the market rising despite the successor not being known reflects investors’ relief. “The prospect of a new prime minister is enticing to investors as they well remember the surge in equities [in] the run up to the election of Mr Abe in 2012,” says Madden.

In 2012, Japanese stocks rose almost 23% after Japan’s then incoming government vowed to reinvigorate the long-suffering economy. Japanese equities had been in recovery mode after hitting a low in 2012 caused by the devastating earthquake and tsunami that hit in 2011.

But despite recent strength, Japan’s stockmarket has been unloved and misunderstood over the last several years.

So why have Japanese stocks underperformed relative to other markets?

Japan has been beset with decades of deflationary pressures, and despite efforts to prop up prices, deflation has remained stubbornly high.

When inflation is high, it means asset prices are rising and it encourages investment in the stocks. The opposite applies in a period of deflation where asset prices are falling, meaning cash and other liquid assets look more attractive.

Japanese markets have suffered the longest downward trajectory in any major stock market in living memory. In December 1989, the Nikkei index reached a record high of almost 39,000, but only regained the 30,000 mark earlier this year.

Adding to that was a downward trend in treasury yields. For the last 20 years, Japan’s market was largely a trader’s market. Investors could follow an active approach and make money by buying specific company stocks that looked more promising than others, while neglecting the overall market. Investors who chose to trade the entire market had to make sure they got their timing right, which meant it was hard to make returns.

But over the past decade, Japanese equities have fared better than the previous two decades. What changed?

The answer simply points to one man: Shinzo Abe.

Shinzo Abe’s sweeping changes

In 2014, the then prime minister, Shinzo Abe, initiated a push to modernise the country’s corporate governance. He encouraged businesses to appoint more outside directors to boards and made delivering value to shareholders a core focus.

Wouldn’t that be expected anyway from a major economy? As AVI Japan Opportunity Trust’s Joe Bauernfreund told the MoneyWeek Podcast, Japan’s market has historically been different, as post-war attitudes were much more collective and stakeholder focused than shareholder focused; Japan was much more interested in keeping as many people employed as possible, rather than focusing on specific shareholder needs.

But since the Corporate Governance Code and Stewardship code were introduced, there has been an uptick in corporate activity.

What is the outlook?

So with that in mind, should you buy Japanese stocks?

Japanese stocks are rising as investors are only now realising how cheap they are, says Shoichi Arisawa, general manager at investment banking and brokerage firm, IwaiCosmo Securities.

Suga’s exit has also triggered a rise in the country’s telecommunication companies. Shares in Japanese telcos, Nippon Telegraph & Telephone Corp and KDDI Corp have shot up since Suga’s resignation on hopes that the country’s new successor will have more favourable policies towards the country’s mobile-phone industries. Reducing the cost of mobile plans was a major focus for Suga during his short-lived premiership and even before that while he held the position of chief cabinet secretary in 2012.

Another reason to buy is the Nikkei’s low price/earnings (p/e) ratio of 13, which is “cheap” according to Arisawa. The US market is on a rating of around 22, so it’s definitely worth keeping Japanese stocks (and particularly the nation’s telcos) on your radar.

For Japanese growth stocks, look at the Baillie Gifford Japan Trust (LSE: BGFD), while those interested in value should consider the AVI Japan Opportunity Trust (LSE: AJOT).