Japan stock market review – the yen carry trade and what’s next

It’s been a tumultuous time since our last Japan sector review in July 2024.

While the summer months can often be quieter for markets, August this year was an exception.

Here’s what happened and what it meant for stock markets.

This article isn’t personal advice. If you're not sure if an investment is right for you, ask for financial advice. All investments fall as well as rise in value, so you could get back less than you invest. Past performance also isn’t a guide to future returns.

The yen carry trade

Investors saw an unusual period of market volatility this summer. Within the first five days of August, the global stock market fell 5.75%. Worst still, the main Japanese stock market fell 15.60% – its biggest daily fall since 1987.

The fall was largely the result of a reversal in the so-called yen carry trade.

With interest rates so low in Japan, some investors had previously taken the opportunity to borrow in the ‘cheap’ yen and invest in other countries with higher rates and potential investment returns on offer, like in the US stock market.

Japan has had low and even negative interest rates for years to try to exit its decades-long period of deflation. But with inflation above the 2% target for the last two years, at the end of July the Bank of Japan decided to raise interest rates for the second time since 2007.

The Japanese yen soared as a result and pushed borrowing costs higher. This saw traders who had parked borrowed money in the US scramble to limit their losses by paying back what they borrowed.

This, combined with some pessimism around the strength of the US economy, led to an unwinding of the carry trade, dragging down broader markets with it.

While the market falls were swift, they later recovered, helped by some strong economic data from Japan.

The country’s gross domestic product (GDP) – a measure of economic growth – grew 3.1% year on year for the three months to the end of June 2024. This beat the consensus of 2.3% and was supported by consumption which in turn was supported by wage growth.

The market rebound meant that by the end of August, the Japanese stock market had only fallen 1.77% in sterling terms, offsetting most of the losses seen earlier in the month.

Fumio Kishida set to step back

Japan was once one of the few countries in the world without an election scheduled for 2024. But that could be set to change after Prime Minister Fumio Kishida announced he would not stand for re-election as leader of the Liberal Democratic Party (LDP).

Kishida’s resignation hasn’t come as a huge surprise though. While he’s been a market-friendly prime minister and built on the reforms of previous prime ministers Shinzo Abe and Junichiro Koizumi, he’s suffered from low popularity in opinion polls for some time.

Kishida’s three years in office will end in late September at which point the LDP will elect a new prime minister. There are nine candidates, and there’s the potential for Japan to see its youngest ever or first female prime minister.

While Japan is coming out of an era of low growth and deflation, any new prime minister will have to contend with rising prices and a weak yen that are weighing on household finances and consumption.

How have Japanese stock markets performed?

Despite the ups and downs, most major global stock markets, including Japan, have performed well over the past year.

The MSCI Japan Index grew 15.79%* over the year to the end of August 2024. This is behind the 19.55% return for the broader global stock market though, which has been boosted by the US and technology companies, but it’s still an impressive return. As always, past performance isn’t a guide to future returns.

Elsewhere, there’s been a difference in the way value and growth companies have performed.

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

The value style underperformed growth for many years and experienced its worst year in recorded history during 2020 as the pandemic took hold. However, the announcement of the first COVID-19 vaccine in November 2020 acted as the catalyst for a comeback in value investing.

A push to improve the corporate governance standards of Japanese companies has also had an impact here.

These changes have had a greater impact on companies with low valuations, as many were seen to have lower corporate governance standards.

Over the past year, the broader index of Japanese value companies has grown 18.49% while growth companies have returned 13.04%.

There’s also been a difference in performance between larger companies and higher-risk small and medium-sized companies.

Some larger companies that are more international in nature or offer a more diversified range of products and services have performed well. More domestically focused small businesses haven’t fared quite so well, though have still returned 9.01%.

That said, this means some investors and fund managers believe there’s now more value and better growth potential among smaller companies.

The chart below shows this one-year performance, as well as the dramatic sell off in August.

How have Wealth Shortlist funds performed?

Japan’s stock market is often style driven. This comes down to lots of Japanese companies showing traits and characteristics that define either growth or value investing.

So, when a rotation in style occurs, it can impact performance.

Over the last year, value companies have outperformed growth.

Remember, fund managers with different strengths, styles and areas of focus will perform differently in different economic conditions. A year is also a very short time frame to look at performance – investing should be for at least five years.

For more details on each fund and its risks, use the links to their factsheets and key investor information below. 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.