Despite big rally in Nikkei stocks, we recommend Japan’s value names

For Japan stock market participants, the big rally which have pushed key market indices close to their 1989 highs could not have provided a better start to 2024. Japan has become overseas investors’ darling in Asia helped mainly by fading interest in Chinese stocks which was on top of most brokers’ buy list this time last year. Indeed, there is an element of buying Japan by default in play here.

However, we remain unconvinced that this latest leg led mainly by index futures buying and triggered by January’s retracement of the dollar/yen rate is sustainable. We suspect this month’s rebound in the dollar/yen rate looks unlikely to continue and its mainly a reflection of deflating expectations of an early Fed pivot which led to a huge rally in US treasuries late last year. With latest data suggesting there is still some ways to go before inflationary pressures are tamed, there has been some adjustment in the currency market positioning that has strengthened the dollar recently. 

Nevertheless, we think chances remain high that US interest rates peaked in Q4 of last year and long bond yields seem very unlikely to spike notably above 4%. Although supply of new bond issuance has crept back in as one major concern, and geopolitical risks are as high as ever and conflicts in Eastern Europe and Middle East is threatening to disrupt trade, we feel that overall bond yields should still remain on a gradual downward trend as global economies slow down.

Meanwhile, in Japan despite recent weakening of economic indicators, core inflation remains well above BOJ’s target and big base wage hikes seem to be on the cards for April. Thus, it is difficult to see BOJ sticking with its quantitative easing beyond the first quarter of this year. We think these two above scenarios together should ensure that the dollar/yen will test its December lows this quarter and deflate the shares of exporters that have led Japan higher this month. 

To be sure, we believe the secular bull trend in Japan’s value stocks remains firmly intact as Japan Exchange is about to further tighten the screws on companies that have yet to improve their shareholder returns and those whose stock prices remain below their book value. However, this latest rally has been mainly led by Japan’s corporate champions, mostly the multinationals which have for years outperformed the broader market and whose overseas earnings have been flattered by the weak yen in the past two years.

Thus, the composition of the latest rally led by high priced stocks does not suggest that this is at all related to positive changes being adopted by Corporate Japan which led to a big rally in value stocks in Q2 and Q3 of last year.  We thus retain our negative stance in shares of some of the big manufacturing exporters, namely autos and semiconductor-related names which have already strongly outperformed for much of last year. Meanwhile, we remain more positive in regards to value names where we expect big changes in corporate governance, restructuring and higher returns to shareholders.