Japanese stocks have started off the year 2024 with a bang, reaching three-decade highs. This surge in the market can be attributed to two key factors: a weaker yen and the expectations of persistently low interest rates. The Nikkei has experienced a remarkable 6% gain over the past two weeks, marking the best start to a year in a generation, as reported by LSEG data. This incredible performance follows a 28% jump in the index’s value last year, the largest annual gain in a decade. Chart levels are breaking, and hedge funds are now eagerly chasing the momentum, with market participants predicting that the index could soon reach its peak from 1989 at 38,957. The influx of cash from both domestic and international sources is further fueling this rally.
In the first week of January, foreigners were net sellers if derivative trades were taken into account. However, they were active buyers of cash equities, as confirmed by exchange data. Sales desks have reported that the following weeks saw even more buying activity, with sellers becoming scarce. Over the course of 2023, foreigners invested an impressive 6.3 trillion yen ($43.5 billion) in net equity purchases, the largest amount in a decade. Tareck Horchani, the head of prime brokerage dealing at Maybank Securities, stated that the volume in January has already been nine times greater than that of December. This surge in demand is particularly evident in the technology sector, where long-short equity funds and global investors who were previously hesitant to invest in Japan are now finding conviction.
A Promising Economic Outlook
The attraction of the Japanese market lies in its domestic economy, which is emerging from decades of deflation. Moreover, the export sector is being supported by a weak yen, making Japanese goods more competitive in international markets. The expectations of maintaining a supportive monetary policy have been further strengthened by a deadly earthquake off the west coast in January. Core inflation is stabilizing just above 2%, and the Bank of Japan has shown no signs of hurrying to counteract it. This has resulted in the yen remaining cheap by historical standards, with traders anticipating negative interest rates at least until April. In contrast to global markets, which have experienced a 0.5% dip in the early part of the year, Japan’s market has seen an absence of sellers, supporting the strong share prices. Analysts at Nomura believe that the Nikkei 225 index’s rise won’t stop at 35,000, with a forecast range of 33,000 to 37,000 for January to March. Kenji Abe, a strategist at Daiwa Securities, predicts that the index will reach 40,000 by the end of the year.
The rally in Japanese stocks is also fueled by a shift in market leadership. In 2023, the Tokyo Stock Exchange’s efforts to improve corporate governance and address Japan Inc’s weak balance sheets drove stock buybacks, cross-holding sales, and price gains. However, the precision-instrument sector, comprising companies involved in semiconductor and software manufacturing, is now experiencing the fastest growth. Richard Kaye, a Japan-based portfolio manager at asset manager Comgest, noted that large foreign investors, who were previously under-exposed to the market, are now taking notice. The hidden jewel companies in this sector are attracting significant interest, as their stocks have doubled in price since May 2023.
Persistent Strength Amid Potential Risks
While the recent gains have been impressive, the speed and scale of this rally also pose risks. Technical indicators are flashing warning signs, with Nikkei volatility spiking and the relative strength index reaching 73.63 (readings above 70 indicate overheating). A rise in the yen and a rotation out of exporter stocks also present potential risks to the market. However, there are signs that these gains can be sustained. Bank of America has observed a weakening yen and the anticipation of wage increases, similar to the backdrop of a rally that lifted the Nikkei almost 20% between April and June of the previous year. Furthermore, tax breaks that have been overhauled could encourage buying from domestic investors. As stated by Pepperstone analyst Chris Weston, “Strength begets strength.”
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