It was a wild summer. In the span of a few days in late July, the market got live to two contrasting theories at once: that U.S. inflation is collapsing while Japanese inflation will remain stubbornly high. Hang around the markets long enough and you’ll see everything.
The market violently repriced interest rate differentials between the two countries, reversing the so-called yen carry trade.
The trade is characterized by borrowing in low-yielding yen to invest in stocks, overseas currencies, real estate, whatever your heart desires. As the low-yielding yen became not-so-low-yielding, positions were unwound, sending investors into a situation where they had to rapidly dump their speculative positions, many of which were Tokyo-listed stocks.
At the August lows, the Nikkei 225 changed hands for 32,077, down from an intraday high of 42,426 a few weeks prior.
We said at the time—and continue to say—that the action appeared unwarranted. Part of the unwind in the yen carry trade was the Bank of Japan’s (BoJ) rate hike, which took overnight money from 0.10% to “around 0.25%.” Our reaction? We were surprised that the market was surprised; the central bank had been telegraphing a rate increase for months.
Since then, things have settled down. Investors have come to realize that there will still be a yawning gap between the two nations’ cost of money even if the Fed Funds Rate gets the chainsaw. The Nikkei is back up to 37,723.
For most of our careers, Japan was not the place to go hunting for dividends. A glance at MSCI Japan’s 2.1% dividend yield doesn’t help the optics. Then again, the S&P 500 is only throwing off 1.3%. Suddenly the 2-handle on Japan isn’t half bad.
Broad Japan is trading for 15x forward earnings, only slightly ahead of the average over the last ten years. JP Morgan is penciling in earnings growth of 13% in 2024 and another 9% for 2025. For context, the S&P 500 trades for 22x forward earnings, with the Street expecting an 11% profit increase this year and 15% next year. Incrementally, UBS anticipates Japanese stocks’ collective return on equity (ROE) will increase from 9% to 10%. That should close the gap with the U.S. a tad, though Japan is still a long way from rivaling the S&P’s 17% ROE.
The country continues to have catalysts, namely in the form of retail participation. Flows into the newly expanded NISA retirement program, which is like a 401(k), have been taken positively. Last spring’s nationwide wage negotiations also resulted in a year-over-year (YoY) pop of more than 5% in take home pay. That leaves workers besting core inflation, which is up 2.8% YoY. One area of concern is the BoJ’s thinking: it figures inflation has upside risk into 2025.
That upside makes sense because Q2 GDP came in at a +2.9% annualized pace. Still, BoJ head Kazuo Ueda does not appear to be concerned that things will run too hot. The big statement from last week’s meeting, whereby the BoJ decided to hold rates steady: “We have some time to decide policy.”
Doves have latched onto that single sentence. Some say the BoJ will be Steady Eddie until Q1/2025. If the central bank does take its time, then next year should be one that witnesses double-digit growth in earnings, dividends and buybacks.
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