The Yen’s Shift: A New Opportunity for Japanese Stocks
The Japanese stock market has enjoyed a remarkable surge this year, driven in part by a weakening yen. However, recent developments suggest a shift in the currency’s trajectory, potentially impacting investor strategy. While the yen has started to strengthen against the dollar, experts believe that the Japanese equity market remains a compelling investment opportunity, thanks to strong corporate fundamentals and a historical record of outperformance during periods of yen appreciation.
Key Takeaways:
- A Strengthening Yen: The Bank of Japan’s recent interest rate hike has led to a strengthening yen against the dollar, after a prolonged period of depreciation.
- Limited Impact on Earnings: While a strengthening yen could impact corporate earnings, experts believe the impact will be modest and largely offset by strong earnings growth and corporate reform in Japan.
- Boosted Returns for Foreign Investors: The strengthening yen will benefit foreign investors by boosting the dollar value of their Japanese stock holdings, creating an attractive opportunity for overseas capital to flow into the market.
- Historical Trends: Historical data suggests that the Japanese stock market often outperforms during periods of yen strength, indicating a potential for continued growth in the coming months.
- Gradual Entry: Experts recommend a gradual approach to investing in Japanese stocks, taking advantage of any potential short-term dips in the market to scale into positions.
The Shifting Landscape: Yen’s Impact on Japanese Stocks
The Japanese stock market has seen a significant rise this year, with the Nikkei 225 index reaching record highs. This surge has been partly attributed to the weakening yen, which boosted corporate earnings and fueled interest among foreign investors. However, the tide appears to be turning, as the yen has begun to strengthen following the Bank of Japan’s surprise decision to raise interest rates in late July. This move was designed to address the growing interest rate differential with the U.S., a key factor driving the yen’s sustained weakness.
Navigating the New Course: Strategies for Investors
While some investors may view the strengthening yen as a cause for concern, many believe it presents a unique opportunity to capitalize on the Japanese stock market’s potential. Several factors point to a resilient outlook despite the currency’s shift:
Resilient Corporate Earnings
Despite the risk of a stronger yen impacting corporate profits, experts argue that the negative effect will be limited. Many companies have already factored in a weaker yen into their budgets, while others stand to benefit from strong economic growth and corporate reform initiatives.
"In Japan, we see above-consensus earnings growth of 10-11%, supported by nominal reflation and corporate reform, which we don’t think are disrupted by recent volatility," said Daniel Blake, strategist at Morgan Stanley.
Favourable Historical Trends
An analysis of historical trends reveals a compelling case for Japanese stocks outperforming during periods of yen strength. Jefferies research shows that in the past four cycles of yen appreciation, the MSCI Japan index fell by over 7% in yen terms but delivered a robust 24% gain on a dollar basis, even surpassing the MSCI All Country World Index by the same margin.
"This suggests that, if the cycle is heading towards [a] period of persistent yen strength, global investors should overweight Japan," Jefferies emphasized.
Attractive Entry Point
Despite the recent volatility, the yen still remains relatively undervalued, according to experts like Peter Perkins of Macro Research Board Partners. This presents a compelling opportunity for foreign investors to gain exposure to the Japanese market at attractive prices.
"Of course, the move from 163 to 147 is a reminder that things can change relatively quickly. … Gradually increasing exposure and taking advantage of any weakness we think would be the right thing to do," Perkins advised.
A New Chapter for Japanese Stocks
The changing dynamics of the yen present a compelling case for both cautious optimism and strategic action. While the currency’s direction remains uncertain, the underlying fundamentals of the Japanese stock market are strong. With earnings growth exceeding expectations, a history of outperformance during yen appreciation, and a still-undervalued currency, Japanese equities may offer a compelling opportunity for investors looking to diversify their portfolios and capitalize on international market growth.
