Japan: A Stealth Bull Obscured by a Weak Economy and Currency

Today’s Japan Story Not a 1980s’ Rerun


  • Japanese equities have finally surpassed the previous high set in 1989.
  • 1980’s rally driven by excessive optimism; current rally driven by profit growth and a weak yen.
  • We believe the case for Japan now compelling, given cheap valuation, strong earnings.

The Nikkei 225, Japan’s oldest stock index, recently surpassed the 40,000 level. This is quite a milestone as it has taken 34 years to break above 39,000, its previous high made in December 1989. This makes it one of the longest bear markets for any major stock index in post-WWII history. While a 34-year bear sounds terrible, it might surprise many to realize that, excluding dividends and ignoring currency effects, the Nikkei has managed to keep up with the Dow Jones Industrial Average index since 2009. What’s more surprising is that this period encapsulates one of the best 16-year periods for US stocks, as shown in Chart 1, below. However, as we will show, this comparison is somewhat misleading.

Source: LSEG Datastream, RiverFront. Data daily as of May 24, 2024. Chart shown for illustrative purposes only. Past performance is no indication of future results. Not indicative of RiverFront portfolio performance.

Looking closer at the rise in the Nikkei’s price, we believe that it has been driven by two major factors: Japan’s export-oriented companies being boosted by a weaker yen, as well as by an increased focus on corporate efficiency. The first factor is a double-edged sword for US investors, as the yen depreciated by over 40% over the same period. However, the improvement in profitability, coupled with the opportunity to buy Japan at cheap stock and currency prices, is now much more compelling than it has been, in our view, both relative to its own history and comparing Japan to other similar markets.

1980’s Japan Was a ‘Hare’…

In the 80’s, the Japanese stock market experienced fast acceleration off the starting line, much like the proverbial hare. It took just 5 years for the Nikkei to increase from 9000 at the beginning of 1984 to 39,000 by the end of 1989. From an economic perspective, Japan was a dominant and growing supplier of automobiles, consumer electronics, semiconductors, and industrial machinery. In contrast to the last 15 years, US investors saw especially strong returns, as the yen also rose 75% relative to the US dollar over the same period.

However, the rise in stock prices far exceeded any fundamental improvements, in our view. Declining interest rates added fuel to the fire, providing liquidity to a speculative boom in both real estate prices and stocks. Eventually, Japan’s economic competitive advantage proved unsustainable, as other Asian economies quickly created clones of Japanese businesses. These declining fundamentals ultimately caused Japanese equities and the economy to collapse, leaving a country already saddled with poor demographics with massive amounts of debt as well. As a result, Japan was relegated to two decades of listless performance. Just like the story, the hare’s pace was unsustainable.

…But Since 2009, Japan More Like the ‘Tortoise’

Since 2009, returns to US investors from Japanese stocks - taking Yen weakness into account - have been more reminiscent of the proverbial ‘tortoise’, growing only 6.2% per annum. Thus, the rise in Japanese equities since 2009, while impressive in Yen terms, has been more of a slow burn with much less fanfare in US dollars. There are several reasons for this, illustrated in Chart 2, below:

Source: FactSet, RiverFront. Data daily as of May 23, 2024. Chart shown for illustrative purposes only. Past performance is no indication of future results. Not indicative of RiverFront portfolio performance.
  1. Japanese equities tend to have much lower dividend yields – this is one of the reasons why there is a significant total return performance gap between the MSCI Japan and the Dow.
  2. While Japanese stocks were up 333% in local terms on May 23, 2024 (see Green Line in Chart 2, above), US investors ended up with a much paltrier 151% (see Yellow Line in Chart 2) due to Yen weakness.
  3. Japan and every other major index in the world were overshadowed by the growth in earnings that came from US Technology leaders that dominate the Nasdaq 100, as well as the higher multiples awarded to those earnings. The more common Index we use for US Large Cap equities, the S&P 500, has a much larger weight in these high growth themes than MSCI Japan or the Dow.
Source: FactSet, RiverFront. Data annually as of December 31, 2023. Chart shown for illustrative purposes only. Past performance is no indication of future results.

As to the macro reasons for underperformance, we see a mixed picture. One thing that has continued to hang over Japan is persistent deflation, which has contributed to Japan having an exceptionally high debt to GDP ratio – it currently sits at over 200%. This combination has necessitated 0% interest rates for a long time.

On the other hand, since 2012, Japan has embraced an enhanced corporate profitability model (coined ‘Abenomics’ in honor of its’ primary champion, the late prime minister Shinzo Abe). The impact of these competing narratives has been a doubling in the profit margins of Japanese companies from 3% to 7%, as seen by blue line in Chart 3 (above), but a stagnation of price-to-earnings (PE) multiples, as shown by the orange line. This represents another contrast to US markets, which have seen valuation multiples expand over this time period. While Japan’s multiple stagnation has hurt relative returns over the past decade, looking forward it may provide an interesting investment opportunity in our view, when paired with improving fundamentals.

One of the hurdles that Japan has now successfully cleared is navigating the liftoff from zero interest rates. Initially, we were skeptical of how the market would fare, but seeing positive returns compels us to take a deeper look. With what we discussed today, we can better contextualize the earnings analysis we performed in last week’s Weekly View.

Conclusion: We are Optimistic About Japan in International Markets

As we think about our level of investment in Japan in our balanced portfolios, the discussion above provides a convincing case for Japan as a preferred investment for our developed markets. Our Price Matters® framework for long term valuation has been suggesting attractive valuations in international markets for a long time – this is further strengthened in Japan’s case by a cheap yen. While we still see higher economic and earnings growth rates in the US on a forward-looking basis, we believe Japanese equities are proving to be an unsung hero that has stealthily developed a track record of profitability and earnings growth, all while maintaining low multiples due to macro challenges. While Japan continues to face demographic and debt challenges, the strength and steady growth of Japanese earnings makes the country attractive to us within the international sleeves of our balanced portfolios.

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.