Japan’s Exit from Negative Rates: A New Era for Japanese Equities?

15 Apr 2024

By Danish Lim, Investment Analyst, Phillip Nova

 

The Japanese stock market has been on a stellar uptrend, seemingly hitting new fresh highs after every trading day. As of 12 April, the Nikkei 225 Index (+18.64%) has outpaced both the S&P 500 (+9.44%) and Nasdaq (+9.06%) in terms of total return YTD.

Many of the driving factors behind the exuberance in Japanese equities have been elaborated and much discussed, this includes structural factors such as improving corporate profits, Buffett’s endorsement, exit from decades-long deflation, and corporate governance reforms. A weak Yen has also served as a key tailwind for Japanese exporters such as Toyota.

We believe the Bank of Japan’s recent decision to end its negative interest rates regime could be a major inflection point and we discuss its implication for the Japanese stock market.

 

End of Japan’s negative interest rate regime:

Source: Bank of Japan

 

On March 19, the BoJ signalled that its price stability target of 2% is “in sight”, and decided to overhaul its monetary policy:

  • The BoJ exited its negative interest rate policy, and will guide the short-term interest rate (uncollateralized overnight call rate) within the range of 0 – 0.1%.
  • Scrapped its Yield Curve Control (YCC) – which involved a soft cap of 1% on 10-year JGB yields. But will continue to purchase long-term JGBs at roughly the same pace
  • Discontinued new purchases of ETFs and J-REITs.
  • The BoJ emphasized that “accommodative financial conditions will be maintained for the time being”, given the current outlook for economic activity and prices.


The Nikkei 225 Index surprisingly saw a gain of 0.66% on the day of the BoJ move. We attribute this gain to markets having a dovish interpretation of the policy manoeuvre – viewing it as a “one-and-done” move.

 

Implications for equity markets:

A key risk for the equity market involves the BoJ hiking rates more than expected, thereby strengthening the Yen and weighing on export-oriented stocks. We believe Yen direction will also depend heavily on the Fed, given the prevalence of Yen carry trades. An early Fed rate cut and hawkish BoJ could strengthen the Yen and weigh on equities.

  • With the interest rate trajectory still uncertain, we favour currency- hedged ETFs which are able to help hedge yen fluctuations. This includes WisdomTree Japan Hedged Equity Fund (DXJ) and iShares Currency Hedged MSCI Japan ETF (HEWJ).

Nevertheless, the macro story remains intact, and structural tailwinds such as corporate reforms and geopolitics should underpin the Japanese stock market. We expect rising wages and a return of inflation to have a positive impact on the economy through stronger sustained consumer spending.

In this scenario, we anticipate a longer-run outperformance of Japanese stocks. Investors can gain broad exposure to Japanese equities via the iShares MSCI Japan ETF (EWJ).

From the above chart, we see that the value factor has outperformed YTD. Value stocks tend to outperform in an inflationary environment- where inflation, interest rates, and economic growth are rising.

  • We like value-oriented stocks that benefit from corporate governance changes and are linked to high dividend yields and share buybacks. This include ETFs like MSCI Japan Value ETF (EWJV) and WisdomTree Japan SmallCap Dividend Fund (DFJ).


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1) Has the ARKK been sunk?

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2) Searching for exposure to Asian equities?

iShares MSCI Asia ex Japan ETF (AAXJ) The AAXJ is currently trading -10.6% adrift of all-time highs seen in February, giving up gains in tandem with an Asia-wide equity sell-off at the time. Given that slightly over 40% of the ETF’s holdings are based in China, the ongoing tumult seen in Chinese equities currently have carried over nearly perfectly in the AAXJ, as Chinese investors take a breather after the stellar gains made over the past year. Looking ahead, Asia – and particularly China, is steaming ahead with its economic recovery. China is widely expected to be one of the best-performing major economies this year, providing a major boost to the outlook for corporate earnings. As the rest of Asia and the world gradually opens up their own economies, AAXJ is likely to again benefit from strong Asian outperformance amidst a strengthening trade outlook.

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