Japan's rally will impact flows into other mkts: Bank of America's Akutsu

In a Q&A, the bank's Chief Japan Equity Strategist says yen depreciation this time around is benefitting stock prices and Japanese markets will finally surpass the lifetime highs made 34 years ago

Japan has been the standout global market this year with its benchmark Nikkei 225 index soaring more than 20 per cent to reach 1990 highs. Masashi Akutsu, Chief Japan Equity Strategist, Bank of America, explains what is driving the new-found interest in the world’s third-largest economy. In an interview to Samie Modak, Akutsu says the yen depreciation this time around is benefitting stock prices and Japanese markets will finally surpass their lifetime highs made 34 years ago. Edited excerpts:

What is the reason for bullishness towards the Japanese market?

Structural changes are a key factor behind the revaluation of Japan stocks. The expected upward shift in base pay following spring labour negotiations is unlikely to be temporary due to labour shortage. Companies are likely to be forced into making significant changes to their pricing strategies. In addition, share buybacks of Topix firms have been increasing. We believe the stock market high of 1989 set during the Bubble Economy will come into sight again, should a core CPI of 1.5 per cent or more take hold in Japan and return on equity (RoE) reaches double digits.

Why has Japan's market traded at low valuation multiples for so many years?

There has been little incentive for companies to radically change their behaviour over the past two decades, resulting in limited use of cash. Above all, it was difficult to boost profitability by raising prices amid the deflationary regime, leading to a relatively low return on equities compared with the rest of the world. However, we believe the arrival of an inflation regime could accelerate corporate reforms.

What is your house view on the Japanese market now?

We expect the Topix and the Nikkei 225 indices to reach 2,300 and 32,500, respectively, by the end of 2023.

Are there any downsides of loose monetary policy or other economic policies in Japan?

The risk would be a premature Bank of Japan policy normalisation given potential higher-than-expected inflation. But this is not our base case, as it might take time to confirm the sustainability of wage inflation in Japan.

Will the rising attractiveness of Japanese markets make other emerging markets in the Asia-Pacific market less attractive?

The sharp rise in Japanese stock prices can be regarded as rational from the viewpoint of correcting low price-to-earnings (PEs) and factoring in improvements to earnings forecasts. We see further upside in Japan equities thanks to the fundamental improvements. Also it is possible that some funds avoiding regulatory risk in China will flow into Japanese stocks as an alternative.

How will the yen movement impact Japan and other global markets?

Last year, the yen’s depreciation was the result of the USD’s sharp appreciation, and considering the way that the USD’s appreciation worsened the global economy, the yen's depreciation was not necessarily a good thing. By raising the prices of commodities, it may have contributed to the deterioration of Japan’s terms of trade. This year, however, three things are different: the appreciation of the USD has paused; commodity prices have peaked; and looser travel restrictions have created a path for the weaker yen to stimulate inbound tourism. This configuration allows the yen's depreciation to work directly on earnings and stock prices. This can be seen in the fact that foreign investors, who were net sellers of Japanese stocks every time the yen weakened and the USD strengthened last year, have switched to large-scale net purchasing.

Will Japan’s outperformance result in lower portfolio flows into other markets?

We think this is possible, given Japan’s limited geopolitical risks and expected inflation regime shift and corporate reforms.

Can you talk about the interlinkages of Japan and the US economy and the markets?

The US economy plays a major role in Japan equities. Particularly, the sticky inflation in the US - driven by the wage hikes - may actually provide a tailwind for Japan equities. As the sticky inflation in the US prevents the Fed from cutting interest rates and weakens the yen, which in turn should benefit Japan equities.