Japan finding its way back on to radar of investors
Japanese share market picks up after slump that lasted 30 years
Several sharemarkets hit new highs during the first few months of this year.
The S&P 500 in the United States topped its previous record from two years ago, European and United Kingdom shares surpassed the highs of 2022 and 2023, while the Australian ASX 200 bettered its mid-2021 peak.
However, the most significant milestone of all came in Japan, where the Nikkei 225 index finally retook the level it reached 34 years ago in 1989.
Japan had a genuine rock star economy in the 1980s, driven by new infrastructure and productivity gains in the decades following World War II.
High quality goods built in technologically advanced factories saw the economy boom, while the reliable, fuel-efficient cars it was producing were a global hit after the oil shocks of the mid1970s.
All of this fuelled a massive property and sharemarket bubble.
The Nikkei tripled in just four-anda-half years, while Tokyo real estate was reportedly selling for more than 350 times its Manhattan equivalent.
At the peak, the land under the Imperial Palace was notionally worth more than the entire state of California.
In the 1980s the US dollar had strengthened significantly, making Japanese goods even more attractive to American consumers.
This put huge pressure on the US manufacturing sector and led to a large trade deficit.
In 1985 at the Plaza Hotel in New York City, the world’s biggest economies agreed to do something about that.
The Plaza Accord saw the US dollar weaken sharply against the Japanese yen, as well as several other major currencies.
It helped the US trade deficit, but hurt Japanese exporters and pushed the country away from the US and encouraged further trade with Asia.
To offset this tougher export environment, Japanese policymakers introduced expansionary monetary and fiscal policies, which contributed to the sharp rise in asset prices.
The bubble burst in 1990, sending property and share prices into a slump that lasted for 30 years. At its 2009 lows, the Nikkei was more than 80 per cent below those heady days of late 1989.
Japan has also suffered from deflation in recent decades. In 12 of the 35 years following 1985, Japanese consumer prices went backwards, with an inflation rate over that entire period of just 0.5 per cent (compared with 2.5 in the US and 2.9 in New Zealand).
Deflation (which is essentially when the inflation rate is negative) isn’t nearly as good as it sounds.
When prices are falling people stop spending and businesses become reluctant to invest or grow. Everyone hoards cash, an economy grinds to a halt, and it becomes an extremely difficult hole to climb out of.
While the rest of us have been trying to knock inflation on the head these last few years, Japan has been trying to create some, and it’s finally working.
Japan saw its inflation rate rise to 4.3 per cent last year, the highest since 1981, and it’s now sitting comfortably around the 2-3 per cent level.
The threat of deflation looks to be over, after Japan’s largest union group announced stronger-than-expected annual wage deals of 5.3 per cent in March, the biggest pay hikes in 33 years.
That was enough for the Bank of Japan to raise interest rates for the first time since 2007, ending eight years of negative interest rates.
These more conventional monetary policy settings added to investor interest in Japan, after a stellar performance in 2023 saw the Nikkei 225 surge 28.2 per cent, even outpacing the mighty S&P 500.
Japanese shares rose another 20.6 per cent in the first three months of this year, storming through those previous highs.
It’s hard to see the gains continuing at that pace, especially if the Bank of Japan keeps normalising monetary policy just as others start cutting rates.
That could see the yen strengthen from its current low levels, creating headwinds for exporters.
We also can’t ignore the demographic challenges the country is facing, or its enormous government debt.
Then again, the rally in Japanese shares hasn’t been because of massive stimulus and a weaker yen alone.
We’ve seen a notable increase in governance standards, with the government reducing corporate crossshareholdings and pushing for companies to have independent directors.
Valuations also look reasonable, even after the gains of the past 18 months.
The Japanese market is trading on a price/earnings ratio of 15.0, in line with its two-decade average and well below 20.4 for the US market (despite earnings growth expectations looking very similar).
Perhaps most importantly of all, Japan (which represents about 6 per cent of world markets) is finding its way back on to the radar of investors.
After being ignored for decades, these recent positive developments might see Japanese shares increasingly included in portfolios as a diversification opportunity, following big moves in US shares.
Mark Lister is Investment Director at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.