Market insights

Weekly market commentary

26.Feb.2024
  • BlackRock Investment Institute

Japan stocks: high can go higher

Market take

Weekly video_20240226

Wei Li

Opening frame: What’s driving markets? Market take

Camera frame

We continue to like Japanese equities even at all-time

highs for three reasons.

Title slide: Why we stay overweight Japan stocks

1: Valuations

This may be surprising but on an equity risk premium basis given the low-rate environment that is still in place in Japan, actually valuations [do] not look too stretched in Japan. Not to mention a large part of the initial rally was also boosted by weaker currency and in dollar terms, actually Japan has done well but not that well. So, there is more to go.

2: Corporate reforms

More than 10 years ago we were already talking about three arrows and Abenomics, but it always has been slow moving. It’s starting to accelerate. If you are talking about the Tokyo Stock Exchange focus on cash management, you look at the return on equities it’s increased now from back in 2010 to now nine percent right now, which is really quite exciting. It’s still [roughly] half the level in the U.S., but reforms, corporate reforms can really help bridge that gap.

3: Earnings

In the same way in the US equity market we’re seeing rate repricing, hawkish repricing, but earnings are offsetting that, in fact more than offsetting, the same is happening in Japan. You look at operating profit in Japan in the latest earnings season it’s grown 17% year on year and that is also recognizing that expectations have been revised higher.

Outro: Here’s our Market take

So, for these key three reasons we continue to like Japan even as it has reached its all-time high and the last time it was at these levels, this all-time high level was back in the 1989, so it is has taken a long time and we do think that momentum can continue for now.

Closing frame: Read details:

www.blackrock.com/weekly-commentary.

Room to run

We see Japan stocks climbing higher on robust earnings, corporate reforms and a Bank of Japan likely worried about returning to a chronic deflationary mindset.

Market backdrop

US stocks jumped last week on further tech earnings beats. US Treasury yields ticked down due to markets pricing out some rate cuts.

Week ahead

We’re watching US PCE data out this week for further signs inflation is falling toward 2% this year as we expect. Yet we expect it to rebound beyond 2024.

We believe Japan’s equity rally has room to run – unlike some past false starts. We think both the macro outlook and company-level developments will drive the next leg. The corporate earnings growth we expected since 2023 is playing out. Yet we don’t see markets fully pricing in positive signs like corporate reforms. We think the Bank of Japan will cautiously wind down its ultra-loose monetary policy to avoid disrupting an exit from decades of no inflation. We stay overweight Japan stocks.

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Beyond the yen

Total returns for Japanese stocks vs. US stocks, 2023-2024

A yellow line in the chart shows that the TOPIX index is near its own new record, outperforming most major stock markets in U.S. dollar terms except the S&P 500.

Past performance is not a reliable indicator of current or future results, and index returns do not account for fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from LSEG Refinitiv, February 2024. Notes: The chart shows total returns for TOPIX, the Japanese stock index, valued denominated in yen and US dollars, and total returns for the S&P 500. The data has been rebased so that 100 = Dec. 30, 2022.

Japan’s Nikkei index hit a record high last week for the first time since 1989, when stocks soared to the point the real estate-driven bubble later burst. Those events led to decades of low or no inflation and mostly flat growth. The TOPIX (yellow line in chart) is near its own new record, outperforming most major stock markets in US dollars except the S&P 500 (green line). What’s driving the stock surge? A weak currency has helped boost the value of corporate earnings made abroad. We expect earnings momentum to stay solid. A stabilising US dollar is not biting Japanese stock returns in the currency as much. And the excess yield investors receive for the risk of holding Japanese stocks over bonds looks attractive. Our positive outlook is about more than a weak yen. Higher inflation is allowing firms to raise prices and protect margins, while wage growth helps to keep fueling consumer spending.

March will be a pivotal month for Japanese markets, with the annual union wage negotiations – likely to shape the inflation outlook – taking place at the same time as the BOJ’s next policy meeting. The negotiations should help signal if inflation has become entrenched. We think the BOJ will end negative interest rates in coming months but will need more evidence of sustained inflation before raising rates further. We don’t see wages growing enough to keep inflation sustainably at the BOJ’s 2% target – and that’s why we don’t think the BOJ will tighten policy as much as markets expect. While not our expectation, we see a risk the BOJ tightens too quickly and too much. That scenario could be more damaging than a slight delay in policy adjustment, in our view, as it could undercut the BOJ’s attempt to end the long stretch of deflation, or no inflation.

Improving profitability

Corporate governance reforms are a key driver of the stock gains. The Tokyo Stock Exchange (TSE) has kept pushing for firms to improve their profitability and return money to shareholders. The TSE has begun disclosing companies that are planning to improve their capital management – a nudge to those that are trading below book value with no improvement plans. Since former Prime Minister Shinzo Abe introduced reforms more than a decade ago, Japanese firms have made some progress on boosting lackluster return on equity – or profitability. That has risen from negative levels in 2010 to 9%, LSEG Datastream data show. It is still half of the US metric, but we think reforms can help narrow the gap. The ongoing earnings season is validating our expectations of robust growth, with TOPIX operating profits up 17% year over year, Bank of America data show.

Alongside these developments, a revamped government tax-free stock investment scheme kicked off this year aiming to stoke domestic investor flows into Japanese stocks. This scheme could facilitate Japanese savers reallocating some savings out of cash and into real assets, including equities, to try to preserve the value of their money in the new inflationary regime.

Our bottom line

We stay overweight Japanese stocks and think they can best their all-time highs. On top of support from the return of mild inflation, we see company-level developments driving the next leg of the rally. We don’t see the BOJ disrupting the optimistic outlook as it likely stays cautious on policy. We see Japanese stocks as attractive given their growth potential.

Market backdrop

The S&P 500 jumped nearly 2% last week, with more tech earnings beats boosting the upward momentum. US tech gains lifted tech stocks globally, and a rally in chipmakers helped Japan’s Nikkei set a record for the first time since 1989. Meanwhile, short- and long-term US Treasury yields fell lower from markets pricing out some Federal Reserve rate cuts this year. We think the positive market sentiment can persist for now as inflation cools and the Fed prepares to cut rates.

This week, we’re closely watching the release of US PCE data – the Federal Reserve’s preferred inflation metric – for signs that inflation is still heading down toward 2% this year as we expect. Falling goods prices have been pushing inflation down, but we see that drag fading in due course. We think inflation will resurge due to stubbornly high services inflation, but we expect that to only become visible later this year.

Week ahead

The chart shows that Brent crude is the best performing asset year-to-date among a selected group of assets, while the 10-year US Treasury is the worst.

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of Feb. 22, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (US, Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Feb. 27

US consumer confidence, durable goods; Japan CPI

Feb. 29

US PCE

March 1

Euro area inflation

Read our past weekly commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, February 2024

Note: Views are from a US dollar perspective, February 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2024.

Legend Granular

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a US dollar perspective, February 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2024.

Legend Granular

Asset Tactical view Commentary
Equities    
 Europe ex UK Europe ex-UK: tactical Underweight -1 We are underweight. We see the European Central Bank holding policy tight in a slowdown and the support to growth from lower energy prices is fading.
Germany Germany: tactical Underweight -1 We are underweight. Valuations are moderately supportive relative to peers, but we see earnings under pressure from higher interest rates, slower global growth and medium-term uncertainty on energy supply. Longer term, we think the low-carbon transition may bring opportunities.
France France: tactical Underweight -1 We are underweight. Relatively richer valuations and a potential drag to earnings from weaker consumption amid higher interest rates offset the positive impact from past productivity enhancing reforms and favorable energy mix.
Italy Italy: tactical Underweight -1 We are underweight. The economy’s relatively weak credit fundamentals amid global tightening financial conditions keep us cautious even though valuations and earnings revision trends look attractive versus peers.
Spain Spain: tactical Underweight -1 We are underweight. Valuations and earnings momentum are supportive relative to peers, but the uncertain outcome of Spanish elections is a temporary headwind.
Netherlands Netherlands: tactical Underweight -1 We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations and earnings momentum than European peers.
Switzerland Switzerland: tactical Overweight +1 We are overweight. We hold a relative preference. The index’s high weights to defensive sectors like health care and non-discretionary consumer goods provide a cushion amid heightened global macro uncertainty. Valuations remain high versus peers and a strong currency is a drag on export competitiveness.
UK German bunds: tactical Neutral We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation.
Fixed income    
Euro area government bonds Euro area government bonds: tactical Neutral We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk.
German bunds German bunds: tactical Neutral We are neutral. Market pricing sets a high bar for dovish ECB surprises and 10-year yields are off their highs.
French OATs French OATs: tactical Neutral We are neutral. Valuations look moderately compelling compared to peripheral bonds, with French spreads to German bonds hovering above historical averages. Elevated French public debt and a slower pace of structural reforms remain headwinds.
Italian BTPs German bunds: tactical Neutral We are neutral. The spread over German Bunds looks tight amid sluggish global macro, the ECB holding policy tight and Italian fiscal policy back in the limelight / fiscal targets under pressure. Other domestic factors remain supportive, namely a more balanced current account. For now, we see income helping to compensate for the slightly wider spreads we expect.
UK gilts UK gilts: tactical Neutral We are neutral. Gilt yields have compressed relative to US Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations.
Swiss government bonds Swiss government bonds: tactical Neutral We are neutral as the Swiss National Bank approaches peak policy rates amid relatively subdued inflation in international comparison and a strong currency. Further upward pressure on yields appears limited given global macro uncertainty.
European inflation-linked bonds Euro area inflation-lined bonds: tactical Underweight -1 We prefer the US over the euro area. We see markets overestimating how persistent inflation in the euro area will be relative to the US.
European investment grade credit European investment grade credit: tactical Neutral We are neutral European investment-grade credit. We maintain our preference for European investment grade over the US given more attractive valuations amid decent income.
European high yield European high yield: tactical Overweight +1 We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the US Spreads compensate for risks of a potential pick-up in defaults, in our view.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, February 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Meet the authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Ben Powell
Chief Investment Strategist for APAC — BlackRock Investment Institute
Carolina Martinez Arevalo
Portfolio Strategist – BlackRock Investment Institute

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