While the nation’s stock market is experiencing a surge, the anticipation of the first rate hike since 2007 looms, potentially tempering the ongoing rally. As Japan’s stock market gains momentum, international investor interest intensifies, but forthcoming rate adjustments could moderate the market’s upward trajectory.
After grappling with a sluggish economy for years, Japan seems to have finally regained its footing towards sustainable growth, evident in the rising wages and exports. This resurgence is drawing foreign investors who are injecting capital into the country’s assets, propelling the Nikkei 225 — Japan’s primary stock market index — to exceed a record set three decades ago. Notably, even Warren Buffett has expanded his holdings in Japanese companies.
Now, Japan’s central bank is poised to conclude the world’s last negative interest rate experiment. While signaling policymakers’ confidence in the economy, this move may also impact investor sentiments.
What has been unfolding in Japan? Following the burst of Japan’s asset bubble in the early 1990s, there has been a downward spiral in land prices, stock prices, and interest rates. Amidst stagnating growth and deflation, the Bank of Japan (BOJ) pursued various strategies to stimulate growth and prices, eventually resorting to negative interest rates in 2016. However, the effectiveness of these policies remains debatable. Although negative rates and quantitative easing weakened the yen and prevented deeper deflation, it took external shocks like COVID-19 and geopolitical tensions to drive inflation above 2%.
This resurgence has fueled a long-awaited revival in the stock market, with the Nikkei rising approximately 18% this year, outpacing the S&P 500’s 7.3% growth. A shift towards a more investor-friendly corporate culture is further attracting foreign capital, especially after upheavals in China’s markets. Concurrently, the Japanese yen neared a 33-year low against the US dollar last year, mainly due to the BOJ’s sustained low rates, contrasting with other countries nearing the peak of their monetary tightening cycles.
What actions is the BOJ taking? Policymakers are gearing up for the first interest rate hike since 2007, although the timing, whether at the March or April meeting, remains uncertain. Wage growth data is being closely monitored as an indicator of the economy’s health. Stronger wage gains would signal an inflationary cycle, providing impetus for rate hikes.
How can one invest? Purchasing shares of an exchange-traded fund (ETF) is the most straightforward way to capitalize on Japan’s resurgence. These funds offer low-cost, diversified exposure and can be bought directly through brokerage accounts. The largest ETF for Japan presently is Blackrock’s iShares MSCI Japan ETF (EWJ), holding large and mid-cap stocks. It has witnessed a price increase of 8.5% this year, with inflows nearing $1.4 billion. According to Noah Damsky, principal at Marina Wealth Advisors in Los Angeles, it’s an effortless way to gain exposure to one of the world’s largest and most developed markets, mitigating the risks associated with individual stock investments.
Other options include the JPMorgan BetaBuilders Japan ETF (BBJP), investing in companies like Toyota Motor Corp. and Mitsubishi UFJ Financial Group. For those interested in specific sectors, BlackRock’s iShares MSCI Japan Small-Cap ETF (SCJ) and iShares MSCI Japan Value ETF (EWJV) cater to smaller market capitalizations and value-focused investment strategies, respectively.
For investors outside the US, accessing US-based ETFs may pose challenges, but comparable alternatives exist in other major markets. In the UK, options like the iShares Core MSCI Japan IMI UCITS ETF (SJPA) and Vanguard FTSE Japan UCITS ETF (VDJP) are available, while Asian investors can explore the ChinaAMC MSCI Japan Hedged to USD ETF (3160 HK) and the Global X Japan Global Leaders ETF (3150 HK) on the Hong Kong Stock Exchange.
What are the risks? One of the foremost risks to Japanese markets is the potential impact of higher interest rates, which could stifle growth and subdue the stock market rally. Growth-oriented companies, in particular, may encounter challenges if rising rates lead to yen appreciation, rendering their goods more expensive abroad. Leyder Murillo, managing director at Wolfpack Wealth Management, suggests considering equity investments in companies poised to benefit from a stronger yen.
Despite the uncertainties surrounding the yen’s future trajectory, investors must be cognizant of exchange rate risks, especially when converting local currency to yen for investments. Notably, recent years have seen the US dollar appreciate against the yen, potentially diminishing returns upon selling Japanese stock holdings.
For those concerned about currency fluctuations, Craig Toberman, partner at Toberman Becker Wealth in St. Louis, recommends utilizing currency-hedged ETFs like the WisdomTree Japan Hedged Equity Fund (DXJ) and iShares MSCI Japan EUR Hedged UCITS ETF (IJPE) to mitigate such risks. These ETFs invest in Japanese companies while hedging against changes in the US dollar and Japanese yen, offering a more secure investment avenue for risk-averse individuals.
