Japanese Stocks Maintain Appeal Despite Yen Strength: Analysts Predict Market Recovery

Japanese Stocks Remain Attractive to Foreign Investors Despite Strengthening Yen

Japanese stocks, which reached record levels earlier this year due to a falling yen, continue to attract overseas investors despite recent currency strengthening. The weak yen, which depreciated 55% against the dollar from January 2021 to June 2024, was a major factor driving foreign investment by enhancing corporate results and increasing the value of gains.

However, the Bank of Japan’s interest rate hike in late July led to a strengthening yen, causing the Nikkei 225 index to fall over 12% on August 5, its worst day since 1987. The yen is currently trading around 144 against the dollar.

Despite this volatility, investor sentiment remains positive. Janus Henderson portfolio manager Julian McManus increased exposure to the Japanese market following the sell-off, and Japan equity funds saw their third-highest inflow of the year in the same week.

Analysts suggest the impact of a stronger yen on corporate earnings may be limited if global growth remains stable. Jefferies estimates that a yen appreciation to 120 versus the dollar could lead to a 10% earnings cut in a soft landing scenario. However, most companies budgeted using the 145 yen-to-dollar level, providing some cushion against currency fluctuations.

Morgan Stanley predicts above-consensus earnings growth of 10-11% in Japan, supported by nominal reflation and corporate reform. Additionally, a strengthening yen benefits foreign investors by enhancing the value of their gains when converted to dollars.

Historical trends show that Japan tends to outperform during periods of yen strength. The MSCI Japan index has previously fallen more than 7% in yen terms but gained 24% on a dollar basis during past yen strength cycles.

Bank of America forecasts a “full recovery” of the stock market by late September or October, with expectations for the market to trade near March highs by year-end. The Nikkei 225 has already recovered from the August 5 sell-off and is up nearly 15% year to date.

Investors are advised to gradually gain exposure to Japanese stocks rather than wait for greater stability. However, exogenous shocks or threats to the Japanese economy or global growth could impact the outlook. Despite recent volatility, the yen remains relatively inexpensive compared to pre-Federal Reserve rate hike levels, when it traded at 103 against the dollar.

As the Japanese market continues to evolve, foreign investors remain optimistic about its potential, balancing currency fluctuations with strong corporate performance and economic reforms.