Japan: Reclaiming Lost Decades

Japanese stocks may help boost the performance of international markets although the unique nature of Japan's economic and business structure could pose some risks.

Japan is home to the world's second-largest stock market after the United States. Japanese stocks make up the largest country weighting in the developed stock market index, MSCI EAFE, at 22%. Yet, Japan often gets little attention from investors. Ask a typical investor what they think of Japan and a common phrase you might hear is "lost decades," referring to the Japanese stock market failing to recover its peak of December 1989. But investors are taking another look as Japanese stocks show signs of finally closing in on their previous high after more than 30 years.

Long Way Back

Japan's stock market, measured by the Nikkei 225 Index, hit a 33-year high last week following 10 weeks in a row of gains Japan's stock market has even outperformed the solid gains for the S&P 500® this year (when measured in U.S. dollars as well as in local currency), as it did last year despite stock markets around the world falling.

Confluence of positives

There are several reasons why Japanese stocks may continue to surprise investors and help lift the performance of international markets.

  • Pro-market reforms are pushing companies to improve shareholder returns. Japanese companies have long hoarded cash, reaching $2.5 trillion, bloating book values but offering little return in a country where interest rates on cash remain below zero. Currently, about half of the 1835 listed firms on the Tokyo Stock Exchange have Price to Book (P/B) ratios below 1.0, including some very large, well-known companies. Earlier this year, the Tokyo Stock Exchange made changes requiring these companies wishing to list on the Prime and Standard sections to provide plans to boost their P/B ratios above 1.0 as soon as possible. This regulatory push is meant to encourage putting idle cash to use in the form of stock buybacks and other measures to help improve shareholder returns.