As Japan welcomed the sakura season this spring, Japanese workers enjoyed their second consecutive year of salary increases, after decades of wage stagnation.
Each year, the spring wage negotiations (or shunto) bring together unions and management to negotiate wages ahead of the start of Japan’s fiscal year in April. This year’s wage round has concluded, and Japan’s largest companies have agreed to raise wages by 5.28%, higher than the 3.58% seen last year.
Wage hikes need to be set against Japan’s inflationary backdrop, with core inflation at a four-decade high of 3.5%. With the 2% inflation target and potential wage increases in sight, the Bank of Japan (BoJ) finally abandoned decade-long policies which were designed to fight deflation.
The BoJ made its historic decision on 19 March 2024 to lift its deposit rate from -0.10%, set its new key interest rate at 0.00-0.10% and remove its 10Y bond yield cap. Though this first rate hike since 2007 came earlier than our April forecast, Japan’s central bank kept a dovish outlook, maintaining that financial conditions would stay accommodative and gave no signal of imminent further rate hikes. Also, the BoJ said it is prepared to buy Japanese government bonds (JGB) if long-term interest rates rise rapidly.
Continuing the momentum from 2023’s 29% gain (total returns based on the MSCI Japan Index), Japanese equities have been off to a roaring start this year. The benchmark MSCI Japan Index (JPY terms) is up 19% in 1Q24, bringing its 12-month performance to an impressive 41%. From a valuation standpoint, the MSCI Japan Index is now trading at a 12-month forward price-to-earnings (P/E) multiple of 16.6x (as of 1 Apr). Although this is 1.1 standard deviations above its 10-year average of 14.8x, the market is still seeing positive upward revisions in corporate earnings.
At Bank of Singapore, we retain our year-long overweight position in Japanese equities in our tactical asset allocation strategy while urging investors to be positioned for the changing dynamics within the market.
Despite the BoJ’s recent rate hike, its monetary policy stance remains accommodative. As real interest rates in Japan remain negative in the near term, this remains a tailwind for the economy and asset values.
However, currency volatility may continue as the USDJPY is largely driven by US-Japan interest rate differentials. Hence, the JPY can react to expected interest rate policies of both the US Federal Reserve (Fed) and the BoJ. Japan’s exit from a deflationary period may also allow the BoJ to respond to currency weakness with additional rate hikes or currency intervention.
Last month’s BoJ rate hike was followed by unexpected weakness in the JPY. However, the USDJPY retreated from near the 152 level on news of a tri-party meeting with the BoJ, Ministry of Finance (MoF), and Financial Services Agency (FSA) on speculation of imminent FX currency intervention.
How does the movement of the JPY affect Japan’s equity market? The correlation of Japanese equity market performance with the USDJPY has been mixed in recent years given the diversified industry exposure of the overall Japanese market. Still, a sharp appreciation of the JPY could result in a short-term pullback in equity prices.
As we expect the JPY to strengthen over the next 12 months, this could be a drag for Japanese exporters, such as the automotive, electronic components, chemicals, biotechnology and pharmaceuticals sectors. Conversely, domestic-oriented companies with USD cost bases may benefit from stronger consumption and USD-priced raw material imports. Retail, food and beverage and real estate sectors are potential relative beneficiaries of JPY strength.
Yet, the effect of short-term JPY moves on Japanese stocks should not be overstated as companies may have already factored the impact of JPY shifts into earnings expectations for respective industries and sectors. Some companies also deploy currency hedging strategies to mitigate the impact of currency moves on their profitability.
With the Tokyo Stock Exchange’s (TSE) ongoing push for Japanese listed companies to carry out corporate reforms to enhance shareholder value, we see potential for increased dividends and share buybacks.
On the domestic front, Japanese equities are benefiting from higher retail participation in stock markets following improved tax incentives that came into effect on 1 January 2024 under the Nippon Individual Savings Account (NISA) scheme. The rise in real wages and inflation expectations could prompt Japanese investors to increase their investments into capital markets for higher returns.
What does this mean for investors:
This article was first published in The Business Times.
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