Japanese fund sector review – what’s a weaker yen done to the stock market?

Japan’s going through a period of change. Decades-long deflation is over, interest rates are rising, corporate governance is improving, and one of its major stock markets recently reached a record high.

So, what’s driving the change? And will it continue?

This article isn’t personal advice. All investments rise and fall in value, so you could get back less than you invest. If you're not sure if an investment is right for you, ask for financial advice.

The path to rate rises

Japan is different to other major economies. It has wanted to push up inflation and see wages grow, and in turn raise interest rates.

At the same time, Japan looks like it’s becoming a more ‘normal’ economy again. This is because of a moderate rate of inflation, ability for workers to negotiate wage growth, and healthy stock market growth.

Prices in Japan have been rising since spring 2022 and inflation currently stands at 2.8% at the end of February, above the Bank of Japan’s (BoJ) 2% target.

This has given workers ammo to negotiate wage rises during this spring’s ‘shunto’ – Japan’s annual wage negotiations. The biggest employers recently agreed to increase wages by 5.3%, the highest increase since 1991.

One of the biggest announcements to come from Japan so far this year was the end of its era of negative interest rates. Rates rose for the first time since 2007, to a range of zero to 0.1%.

This might not sound like much to countries used to much higher rates, but it’s a big change for somewhere that’s only dealt with negative rates and deflation for years.

While rates rose, the BoJ was quick to signal that any more rate rises wouldn’t be rushed, especially until they’re sure inflation will stay around that 2% target.

The BoJ also got rid of its yield curve controls, aimed at capping bond yields to cap borrowing costs. This was an attempt to stimulate the economy alongside negative rates. But it did still maintain its policy of buying around ¥6tn (roughly £30bn) of Japanese government bonds each month.

As for currency, the Japanese yen has kept weakening. While this supports exports and international-facing businesses, it makes more domestically-focused companies less attractive to overseas investors.

Japan marches on

It’s been a strong start to the year for a lot of global stock markets. Japan is no exception and, so far this year to the end of March 2024, the MSCI Japan Index has grown 12.18%*.

This is a short timeframe though, and past performance isn’t a guide to future returns.

This follows a good year for the Japanese stock market. In fact, it’s been on a record-setting rally. The Nikkei 225, Japan’s best-known stock market, was recently the highest it’s been in over 30 years.

Over one year the MSCI Japan Index has returned 23.52% for UK investors. While this is an attractive return, it was hampered by currency movements as the British pound gained value against the Japanese yen. Japanese investors got a return of 43.51% from the same index.

A weaker yen has had other impacts, including contributing to higher inflation. For example, Japan imports a lot of resources, like oil and gas, and a weak yen makes them more expensive. This has helped keep inflation buoyant.

A weakening yen can boost the attractiveness of Japanese goods to overseas buyers though because it makes exports cheaper, benefitting companies doing a lot of exporting.

Elsewhere, there‘s still a big difference in the way ‘value’ and ‘growth’ companies perform.

Growth companies are expected to grow their earnings at a more predictable rate or have exciting growth potential, whereas the share prices of value companies don’t typically reflect their true worth.

Value under-performed growth for years and experienced its worst year during 2020 as COVID-19 took hold. However, the announcement of the first vaccine in November 2020 acted as a catalyst for a comeback in value investing.

Over the past year, the broader index of Japanese value companies has grown 32.59% while growth companies have returned 14.74%.

In terms of sectors, this means companies related to oil & gas, mining, banks, insurance, and transportation equipment have been some of the strongest performers.

On the other hand, pharmaceuticals, textiles, and air and land transportation have struggled.

Overseas investors have been interested in the corporate governance reforms and have aided the performance of lower-valued companies.

The Tokyo Stock Exchange has been pushing to improve the corporate governance standards of Japanese companies. These changes have had a greater impact on companies with low valuations, as many were seen to have lower corporate governance standards.

Japan looks to be on a firmer footing, but it’s faced false dawns in the past, so there aren’t guarantees. The most likely risks to market growth include a slowdown in global growth, particularly in the US – relatively stable growth here has kept demand up for Japanese exports.

Any significant strengthening of the yen could also take the steam out of earnings, though this could see domestic companies do relatively better.

Aside from the economics, Japanese shares currently look reasonably valued, which could bode well for long-term investors. But, as always, periods of volatility should be expected and there are no guarantees.

How have Wealth Shortlist funds performed?

Japan’s stock market is often style driven. This comes down to a lot of Japanese companies showing traits and characteristics that define either growth or value investing. So, when there’s a rotation in style, it can impact performance.

Over the last year, value companies have outperformed growth, which has impacted the performance of Wealth Shortlist funds investing in Japan.

Remember, fund managers with different strengths, styles and areas of focus will perform differently in different economic conditions.

For more details on each fund and its risks, use the links to their factsheets and key investor information. Both funds below invest in a relatively small number of companies, which means each one can have a meaningful impact on performance, but it does increase risk. Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own and they understand the specific risks of the fund before they invest.