How Japan shook off 34 years of stagnation – and beat stock market records

Feb 22, 2024

After 34 years of stagnation, Japan’s stock market is finally waking up to happier times.

On Thursday, the benchmark Nikkei 225 index of the country’s largest companies closed 2.2pc higher at 39,098.68, finally surpassing the previous record set in 1989.

For an economy that has long sought a return to its former glory, it marked a milestone in the country’s recovery.

Technology has come a long way since Japan’s market last peaked, at which point its companies were churning out Gameboys, chunky computers and Walkman stereos.

Its previous success was such that Japan accounted for nearly two-fifths of global stocks in 1989, well ahead of rivals such as the US.

However, soaring stock prices resulted in an asset bubble that burst spectacularly, leaving one of the world’s richest countries stuck in the throes of falling prices and low growth for decades.

The fact the stock market has now eclipsed its 1989 high has fuelled hopes of a much-anticipated comeback. But many are still cautious.

“Psychologically, it is a huge moment,” says Dan Boardman-Weston, chief executive of BRI Wealth Management.

“Probably a whole generation of investors were scarred by the brutal sell-off in Japanese equities in the 1990s and 2000s, only reaching the bottom of the market in 2009. But I think really over the last decade, the fundamentals have dramatically changed.”

The Nikkei 225 is up more than 17pc so far this year, making it the world’s best-performing large index.

Its latest boost came as a consequence of US chipmaker Nvidia beating all expectations on Wednesday, as its revenue soared 265pc to more than £17bn.

Duncan Wrigley at Pantheon Macroeconomics says developments in AI have led to a surge in global tech stocks.

“This boom in generative AI is particularly driving demand for high-end chips and Japanese companies are positioned high up in the supply chain,” he says.

“There are companies like Nikon that produce some of the semiconductor manufacturing equipment and then you’ve got others that make some of the materials.”

As for the broader economy, the latest stock market breakthrough will raise questions about whether Japan’s chronic deflation problem could be on the way out.

The issue of falling prices has come to embody the country’s challenges over the past three decades, as stagnating wages have led to less household spending and subdued growth.

As a result, Japan’s central bank has carried out multiple rounds of digital money-printing, known as quantitative easing, and had negative interest rates for the past eight years.

However, despite the new-found optimism, many analysts fear Japan’s economy is not out of the woods just yet.

“I think the hype is getting slightly overdone”, says Rupert Thompson, chief economist at investment firm Kingswood Group.

“The mistake the last 10 years has been to jump on any of these bandwagons and then find actually it’s another false rally.”

The stock market has been boosted by the weak Yen, which has fallen by more than 10pc against the dollar and the pound over the past year.

But as the central bank is expected to start tightening its monetary policy, Thompson says the Yen is unlikely to have much further to fall.

Wrigley is equally as realistic: “I feel like the stock market has got ahead of the economy in the case of Japan. Much of the domestic economy is still fairly sluggish. The manufacturing sector is seeing declining activity.”

Japan’s economy unexpectedly slipped into recession at the end of last year, abdicating its title as the world’s third-largest economy to Germany.

For investors hoping Japan is on the precipice of returning to a normal monetary environment, where consumer prices grow modestly and interest rates are positive, a recession is bad news.

“This technical recession complicates expectations for the Bank of Japan to normalise its policy stance soon,” say analysts at Ned Davis Research.

“The ongoing decline in consumer and business spending suggests that demand-driven inflation will be harder to come by.”

Wrigley also raises concerns that Japanese families are still too reluctant to spend and their employers too hesitant to boost wages.

“The biggest question in my mind has to do with domestic consumption,” he says.  

“The missing link in this story of Japan normalising is economic growth being passed on in terms of wages to ordinary people.

“Then people get higher wages, allowing them to spend more and then you get a self-sustaining domestic demand-driven economy. That hasn’t happened yet.”

However, there are undoubted green shoots of recovery, and some economists believe the recent reforms initiated by its longest-ruling former Prime Minister Shinzo Abe are finally starting to pay off.

Frédérique Carrier, head of investment strategy for RBC Wealth Management for British and Asia, says investors who are too focused on Japan’s weak economy are missing the point.

She points to corporate reforms by the Tokyo Stock Exchange introduced last year, following other changes brought in under Abe in 2012.

“The government shamed the corporate sector for its notoriously low returns and demanded change,” says Carrier. “As a result, many companies adopted more shareholder-friendly measures, improving disclosures, growing dividends, and announcing share buyback programmes.”

Meanwhile, the Government has introduced tax incentives to get households investing more, she adds. Labour shortages amid a rapidly ageing population and low immigration should help also drive up wages, which have risen by 3.6pc this year alone.

Investors weighing whether to start pouring money back into the Japanese economy face a mixed picture but there is no doubt that the stock market’s latest resurgence will spur a long-awaited wave of optimism.

“Things have changed a lot,” says Boardman-Weston. “It is great to see the market hitting an all-time high even if it has taken half a lifetime.”

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