Japan Enters Global Spotlight for Long Term Strategy

BlackRock holds an above-benchmark allocation to Japanese equities, with strategists confident about the region’s potential future returns.

The firm said that following decades of either deflation or no inflation in Japan, its recent stock market rally has attracted attention from investors.

It noted mild inflation in Japan is bringing higher wages and therefore increase consumer spending, which it said warranted a higher allocation to Japanese equities than the benchmark would suggest.

In March, the Bank of Japan (BOJ) increased its short-term interest rates to 0–0.1%, up from –0.1%, ending its era of negative interest rate policy, which began back in 2016. The increasing interest rates will support the value of the yen and Deloitte predicted the economy will continue to strengthen in the second half of 2024.

Other firms are similarly bolstering their support for Japanese equities. Kate Marshall, lead investment analyst at Hargreaves Lansdown, noted that the rally in the Japanese stock market was predominantly due to a handful of well-performing stocks.

“Like the US, which has been led by the ‘Magnificent Seven’, Japan has benefited from a narrow group of stocks performing well, dubbed the ‘Seven Samurai’. This includes some of Japan’s largest companies, including car maker Toyota and semiconductor companies such as Tokyo Electron,”  she said.

Macro Outlook

BlackRock showed a preference for unhedged exposure over currency hedged in its overweight allocation and the firm is monitoring the market for signs of structural inflows into Japanese equities from domestic savers, given the overhaul to the country’s tax-exempt investment vehicles.

The BOJ’s decision to increase interest rates is expected to improve earnings and margin outlooks for Japanese companies because, after years of cost discipline, these companies will now be able to increase prices and offset pressure on margins from rising wages.

BlackRock noted operating margins at Japanese firms have broadly been stuck in a range of roughly 14-19% for the past two decades, according to Bloomberg data as of April 2024. It said it assumes flat operating margins at 17% but predicts higher sales growth over the next 10 years — 6% compared with around 4% earlier, based on pre-2000 trends and BlackRock’s estimates for future GDP growth.

In addition, Japan's equity risk premium (ERP) has historically been higher than other developed markets, as investors typically demanded extra compensation to own Japanese equities given its relatively low economic growth.

Mega Forces

Large structural shifts such as demographic divergence and digital disruption like artificial intelligence (AI) are impacting economies worldwide, with Japan at the forefront and crosscurrents of some of these mega forces.

BlackRock said understanding how Japan’s revival will interact with the wide-reaching impact of these structural shifts will be crucial in capitalizing on the granular sectoral opportunities where active strategies can thrive.

As a result, active strategies have thrived in Japan’s market due to a disparity in performance within the market. This disparity is also partly due to a difference in responses to new reforms by the Japanese government, according to BlackRock’s research.

The Japanese government has introduced a series of new reforms under Prime Minister Fumio Kishida’s initiative for a “new form of capitalism”. The policies included initiatives to build public trust in the country’s asset management sector, in turn encouraging Japanese people to invest their savings.

This dispersion within the market has benefitted active managers that were able to identify the companies responding well to the new initiatives more quickly and reap the rewards. BlackRock noted earlier this month that global market volatility was creating a bigger role for active managers.