Japan’s record-breaking share market rally earlier this year has become a distant memory as foreign investors begin to retreat from the market amidst a sluggish economy. This shift in sentiment is driven by several factors, including uncertainties in corporate governance reform and the Bank of Japan’s (BOJ) monetary policy. Notably, prominent financial institutions like Citigroup Inc. and abrdn Plc have become increasingly pessimistic about Japanese equities.
Market Sentiment Shifts: Foreign Investors Retreat
Foreign investors, who played a pivotal role in pushing Japanese shares to record highs just a few months ago, are now becoming net sellers. This marks the fourth consecutive week of net selling through June 14, the longest streak since September, according to Tokyo Stock Exchange data. The retreat has been significant, with foreign investors unloading a net ¥250 billion ($1.6 billion) worth of Japanese stocks in the week ending June 14.
Japanese Equities: The Road to a Potential Correction
According to Citigroup analysts, Japanese equities are facing a “material risk of correction.” Factors that once bolstered the market are now becoming impediments. The early optimism, driven by Japan’s unprecedented push to improve shareholder value, has waned. The Nikkei 225 index, which reached an all-time high on March 22, has since stalled, dropping 5.6% compared to a 1% gain for the MSCI AC Asia Pacific Index and a 4.4% advance in the US’s S&P 500 Index.
The Impact of a Weak Yen
The yen’s persistent depreciation has added to investor concerns. While a weak yen historically benefited exporters, the recent decline has raised fears of inflationary pressures and broader economic instability. On Friday, the yen approached 160 per dollar, a level unseen since April, prompting Japanese currency officials to issue warnings against excessive foreign exchange moves.
Structural Changes and Long-Term Outlook
Despite the current market sluggishness, several strategists, including those at BlackRock Inc. and Morgan Stanley, maintain a positive long-term outlook for Japan. They cite structural changes such as corporate reforms, increased domestic investments, and wage growth as potential drivers for future growth. However, the immediate outlook remains cautious as investors await more significant progress in these areas.
Bank of Japan’s Monetary Policy: A Critical Factor
Investor attention is now firmly on the BOJ’s monetary policy. Following the first interest-rate hike since 2007 in March, there is speculation about a potential second hike in July. The Topix index for banks has already surged 30% this year, double the gains of the overall Topix gauge, fueled by expectations of rising borrowing costs and improved lending margins for financial firms.
Comparative Market Preferences: China and India
In the current environment, some investors are shifting their focus to other emerging markets. David Zhou, investment director of multi-asset and investment at Edinburgh-based abrdn Plc, expressed a preference for Chinese and Indian stocks over their Japanese counterparts in the next three to six months. He anticipates that the right policy moves in China and India could attract significant fund inflows.
Corporate Governance Reform: A Lingering Concern
A key issue for foreign investors is the pace of corporate governance reform in Japan. Despite efforts to enhance shareholder value, progress has been slower than expected. Investors like David Zhou believe that more substantial reforms are necessary before foreign investment in Japanese stocks sees a significant uptick.
Investor Sentiment and Market Dynamics
The shift in investor sentiment is evident in the performance of Japanese equities. As the initial euphoria wanes, the market faces critical questions about the sustainability of its earlier drivers. According to Hebe Chen, an analyst at IG Markets Ltd., investors are now grappling with whether the factors that supported Japanese stocks are still viable in the current economic landscape.
Looking Ahead: Challenges and Opportunities
While the short-term outlook for Japanese equities appears challenging, the long-term prospects remain intriguing. Structural reforms, increased domestic investments, and potential wage growth could drive future market gains. However, the immediate focus will likely remain on the BOJ’s monetary policy and the yen’s performance.
Conclusion
In conclusion, the Japanese stock market is experiencing a period of reevaluation and adjustment. Foreign investors, once enthusiastic, are now more cautious, driven by uncertainties in corporate governance reforms and the BOJ’s monetary policy. The weak yen and potential inflationary pressures add to the complexity of the situation. Despite these challenges, there is optimism about Japan’s long-term outlook, contingent on significant structural changes and policy adjustments.
