Which Japanese stocks are likely to continue their rise?

In Japan, inflation is not always a bad thing. (Photo: 123RF)

During a year marked by some volatility, there was one market that remained consistently in the green: Japan. In local currency terms, Morningstar Japan rose 26% year-to-date, while Morningstar Hong Kong fell 16.8%, Morningstar Singapore gained 0.5% and Morningstar Canada gained 2.7%.

Even so, foreign investors may not have seen the same numbers, partly due to the weakening of the Japanese yen. The yen’s weakness contributed to strong exports and corporate profits, but its depreciation also led to currency losses for non-yen-focused investors as they converted their gains into the stronger greenback. Therefore, these losses partially offset the stock’s gains.

This situation may have deterred foreign investors from increasing their allocation to this new popular investor product. But this scenario could change in 2024.

When will Japanese interest rates go back above zero?

Thomas Poullaouec, head of multi-asset solutions for Asia Pacific at T. Rowe Price, continues to favor Japan over other countries such as China. Its portfolios maintain a “very slight underweight to equities”, although the Japanese market represents an overweight position.

As Japan moves its borrowing rates back into positive territory, Thomas Poullaouec thinks the Japanese yen could appreciate. The turning point will occur in the spring, during the “shunt”, or salary negotiations. “The next shunt negotiations will give us hints about the appreciation of wages in Japan. If it stays close to 2% or above that number, it would be a good signal for the Bank of Japan to end its negative interest rate policy,” he explains.

He continues: “I expect the situation to be slightly different in 2024 as the Bank of Japan may take action and end its negative interest rate policy, which will support the Japanese yen.” He believes the yen can still appreciate before hurting corporate profits.

In Japan, inflation is not always a bad thing

Lorraine Tan, director of Asia equities at Morningstar, is also watching rising inflation in Japan. He says: “One positive aspect of the return of inflation in Japan is that it should stimulate or revive reinvestment and expansion activities in Japan itself.” For example, higher business profitability due to rising prices could provide the financial resources needed for expansion. In addition, an increase in wages could stimulate consumer demand.

“If the trend of reinvestment and expansion continues, I think the growth prospects will be more sustainable,” he says. This brings us back to his current choices in the country.

Instead of capitalizing on domestic consumption, Lorraine Tan is focusing on this year’s laggards, such as shares of export-oriented companies. Harmonic Drive Systems manufactures high-precision transmissions, while Nabtesco Corp manufactures components based on motion control technology. Headquartered in Osaka, Daifuku provides automation solutions for warehousing, storage and transportation. Fanuc also manufactures industrial robots.

“Factory automation is sensitive to capital spending around the world, including China. While the outlook for the industrials sector is improving, there are some very good names we like, says Lorraine Tan. These are high-quality companies with a strong economic moat that we believe are underperforming. That’s where we’ll focus our attention.”

Growth in Japanese bank stocks is expected to be limited

This year, the revival of banks and other financial companies has pushed Japanese market indexes higher. Lorraine Tan believes this upgrade has brought the sector closer to its value. She said: “Japanese banks have done very well. We had them at the top of our list for a while, but they’ve come a long way. Opportunities in the financial sector are likely to be a bit more limited in the future,” says Lorraine Tan.

Oliver Lee, portfolio manager at Eastspring Investments, told Morningstar that his Japanese equity portfolio has recently seen gains in financials and autos. “We’ve redirected that capital into Japanese names, defensive stocks and more recently chemical stocks, which are really lagging the market due to weak demand and prices. So we’re still finding a lot of opportunities.”

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