Japan’s domestic-related stocks likely to continue to outperform exporters

Thus far, Japan’s stock market has been behaving relatively well with higher shareholder returns having provided a big boost to sentiment. With Japan’s corporate earnings season half way through its conclusion, we have thus far witnessed a much stronger domestic-related earnings projections as removal of covid restrictions, higher wage growth and strong inbound traffic of tourism to Japan have increased corporate confidence in the related sectors. Meanwhile, manufacturing exporters and multi-nationals have guided for weaker end-demand to continue to weigh on their sales and profits. 

What is also fairly evident is that US regional banking crisis has yet to be resolved and its negative impact on availability of credit has yet to be fully felt. With increasing likelihood of credit contraction in the US likely to dampen hopes for any immediate economic recovery prospects there, we expect this stock market dichotomy in Japan to continue in the near term which should lead domestic-related stocks to continue to outperform exporters. 

This is particularly so as prospects for narrowing interest rate differential between the US and Japan should result in a much stronger Japanese currency this year, adding further headwinds to overseas earnings prospects of Japan’s multinationals. Indeed, with Japan’s core inflation rate looking likely to surprise the BOJ on the upside, we think the central bank will be left with little choice but to further tweak its YCC and allow longer term rates to head higher. 

As we have also argued since March, when the US banking crisis first emerged, with Japan’s central bank owning close to 60% of JGBs and a much bigger portion of the longer dated benchmark bonds, we see very little duration risks facing Japan’s financial institutions. In effect, we believe that risks of falling JGB prices have been nationalised by the central bank.

Moreover, we are already seeing Japan’s institutional investors looking poised to dramatically increase their weighting in Japanese sovereign bonds should yields spike up in response to BOJ’s likely move towards normalisation of its monetary policy. This is likely to put a cap on Japan’s longer-term rates surging to levels that could greatly constrain economic activity while better lending margins should leave Japan’s banks better positioned to keep credit flowing into the private sector. 

Another important emerging trend which we have underlined is the recovery in auto output which as we have argued should lift earnings across many sectors of the economy beyond autos themselves. Although Japan’s car manufacturers are desperately lagging their overseas peers in plans to boost their footprint in the EV market, the disappearance of auto chip shortages should provide a much needed near term boost to earnings of related suppliers.