The Japanese stock exchange has long been known as an eternally cheap market, without any hope of rebound, which rewards investors poorly. And indeed, most Japanese companies were not very generous with their shareholders, preferring to accumulate mountains of cash.
The inflow of foreign investors
Corporate governance was poor, and everything was done to limit the power of small shareholders. All the general meetings were held on the same day to prevent awkward matters. Overall, executives were not judged on their performance.
But things have changed for several years thanks to the measures taken by the authorities. For example, the appointment of genuinely independent directors was encouraged. Noting that the market capitalisation of hundreds of companies is below the value of their assets, the Tokyo Stock Exchange asked listed companies to communicate their plan to improve their value. The goal is to highlight the good students, especially encouraging the bad ones to react. No significant group like Toyota responded to the demand of the stock exchange authorities, believing that their good results were enough to show their effectiveness. And if only 40% of the 1,656 largest listed companies published a plan at the beginning of the year, they were only 20% to do so six months ago.
This progress has not escaped foreign investors, who are now rushing to abandon Japanese gems. Negative the previous three years, net purchases of Japanese shares by foreigners reached more than 40 billion euros in 2023.
Yen and foreign trade
The influx of foreign investors boosted the Tokyo stock exchange by 27% last year. After conversion to the euro, the increase is 15% as the Japanese currency depreciated strongly in the foreign exchange market. This partly explains the excellent stock market performance. The weakness of the currency favours Japanese exports. Above all, it automatically inflates profits expressed in yen made abroad. But the profits that Japanese companies earn abroad do not stem solely from the weakness of the national currency; they are far from it.
To make up for the lack of domestic labour and circumvent customs barriers, Japanese companies have massively relocated their factories to the four corners of the Globe, particularly to Asia. They are now taking full advantage of this advantageous position in the most dynamic region in terms of economy and merchandise trade.
Despite the excellent performance of the export sector, the Tokyo Stock Exchange also benefited from favourable developments at the domestic level. China-US trade tensions have highlighted the need to ensure some economic independence. This has encouraged the revival of specific strategic sectors in the national territory, such as the semiconductor industry.
The return of inflation has also allowed companies to increase sales prices to improve their margins without hurting consumers. The latter have all the more readily accepted the price increase as they have benefited from solid wage increases for the first time in a long time.
An economy on the path to normality
For more than 20 years, the Japanese economy suffered from the absence of inflationary pressures. This depressed domestic demand and gradually gripped all economic cogs. But with inflation above the official target of 2% for 21 months, this long deflationary episode is now over. And that makes a positive difference for the Japanese economy. Being able to increase their prices without scaring customers away, Japanese companies are improving their profitability, which encourages them to be more generous with shareholders and their staff. Stable for decades, the real wage of workers has been rising for 20 months. This should boost domestic demand and trigger a new economic dynamic.
With the sustainable return of positive inflation, the Bank of Japan will come out of its non-standard monetary policy that kept interest rates close to zero. The rise in interest rates will eliminate zombie companies, which are not very productive and innovative but monopolise market share at the expense of future companies.
A still interesting market
All the planets have aligned to promote the rise of the Tokyo stock exchange. Regulatory incentives to strengthen corporate governance, reward shareholders, and improve profitability have increased Japanese equities. It is not too late to take advantage of this because other elements will be added to maintain the positive dynamics of the Tokyo stock exchange in the coming years. Since 1 January, tax incentives have encouraged households to convert billions of yen in cash into shares. The country's economic revival will also benefit the profits and, therefore, the value of the companies.
Concretely, buy 10% Japanese shares regardless of your risk profile. Buy also 5% bonds in yen, which gives hope for a significant gain in the exchange rate.