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Savvy foreign investors are beating a path to Japanese stocks

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Japanese stocks have outshone most other developed markets this year and foreign investors have started to take note. In May the Nikkei 225 hit the highest level in 30 years and within a month, inflows into Japan’s stock market from foreign investors jumped up by 18% to the highest level since data became available in early 1999.

Investors fleeing the inflation-induced malaise in their domestic markets are looking not only to escape the weak performance of their local stocks but also for something that could be described as “the next China”, a market that would provide a similar kind of reliable year-on-year growth that China did until recently.

Japan is presenting itself as that kind of opportunity because of tectonic shifts that have happened in the last year. not only in terms of company regulation but also the attitudes of major Japanese stockholders such as banks and pension funds towards the stocks they invest in.

Most of the foreign investment interest is coming from other Asian countries and Europe, less so from the US. A quick look at global indexes can explain why. The Nikkei 225 and TOPIX, another Tokyo index, are up 25.9% and 21.2% since the start of the year while the FTSE 100 is up 1.22% year-to-date, EuroStoxx 50 up 13.42% and the Shanghai Composite up 1.5%.

The US markets present a slightly more mixed picture with the DJIA up 6.30% YTD but the Nasdaq outperforming all other indices with a 35% rise since January.

Shifting regulation and attitudes

For foreign investors some of the most positive changes stem from the corporate governance and stewardship code introduced a few years ago which has forced companies to become more proactive in creating shareholder value.


In March the Tokyo Stock Exchange announced new rules requiring Japanese-listed companies with a price-to-book ratio below 1 to disclose specific initiatives for improvement including addressing their cost of capital. The move was designed to make it difficult for companies to continue with the “lazy management” scenario in which they hoard cash and instead pushed them to start creating value for shareholders either by increasing dividends or through share buybacks.

Bad governance is less and less tolerated, particularly by foreign investors who are becoming more actively involved. Since the new rules have been brought in the minimum return on equity target was set at 8%.

The price-to-book ratio is the value of a company’s market value divided by the value of the assets on its balance sheet.

Years of a more “stale” approach and a deflationary environment have created rich pickings of undervalued stocks – a fact mentioned by Warren Buffet when he visited the country in April. He said valuations of Japanese stocks were “ridiculously low” relative to interest rates and added that he had started building a portfolio of local stocks since the COVID pandemic in 2020.

On the top of his list were local big hitters such as the industrials Sumitomo and Mitsubishi and investment firms Mitsui and Marubeni.

Bigger picture

Japan’s economy has grown at a solid 2.7% in the first quarter thanks to a recovery in domestic spending, which has offset lower exports caused by slower global growth. The country’s economic conditions are improving while deflation is coming to a close. In many respects, the Japanese economy, given its size and the sophistication of its market, like a very interesting prospect in the second half of this year.

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Hargreaves Lansdown IG Interactive Brokers Interactive Investor Charles Stanley
IG Interactive Brokers Charles Stanley

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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