Late last year, the Bank of Japan (BOJ) surprised investors with an unexpected adjustment of its stimulus program. While the central bank didn’t change the size of its asset purchase program, it did alter the composition of its purchases to include longer-duration bonds, Exchange Traded Funds (ETFs) and REITs.
Investors, however, had been hoping for more, and Japanese stocks struggled in response. The Nikkei 225 benchmark fell 1.9 percent on the day of the announcement, and has lost 1.7 percent since, according to Bloomberg data as of December 30.
But despite Japanese equities’ recent volatility, Japan remains one of the most compelling stock markets globally. Here’s why.
5 Reasons Investors Should Still Consider Japan
As my colleagues and I write in our new Investment Directions monthly market commentary, Japanese valuations look particularly attractive relative to those of other major developed markets. As measured by both price-to-book (P/B) and price-to-earnings (P/E) ratios, Japanese stocks are trading at meaningful discounts to U.S. and European equities. For instance, according to Bloomberg data as of December 30, the MSCI Japan Index was trading at a P/E of 16.1, as compared with 23.3 for the MSCI European Index and 18.3 for the S&P 500.
Perhaps more importantly, Japanese stocks remain inexpensive even as they’ve outperformed their U.S. and European peers, Bloomberg data show. In U.S. dollar terms, Japanese stocks, as measured by the MSCI Japan Index, gained 5.9 percent in 2015 as of December 30, on improving earnings momentum, comfortably outperforming both U.S. and European equities (as measured by the S&P 500 and the MSCI European Index during the same time period).
Continuing Corporate Reforms
This long-term outperformance could continue, not least because the Japanese government has made it clear it’s serious about corporate reform, as part of Shinzo Abe’s three-arrow approach (known as “Abenomics“) involving massive monetary stimulus, increased government spending and significant economic reforms. For instance, just over the last couple of months, the government has announced initiatives including corporate tax cuts. Such reforms could help boost earnings, especially as they’re occurring against the backdrop of a gradually improving economy.
Improving Return on Equity (ROE)
Japanese firms, meanwhile, have placed an emphasis on returning cash to shareholders in the form of dividends and buybacks. According to Bloomberg data as of December 30, ROE in Japan was up 49 percent from year-end 2012, and could increase further this year, assuming Japanese companies can continue to improve their profitability.
Increased Demand for Japanese Stocks
The BOJ and other large institutions have increased their investments in Japanese equities. Meanwhile, the recent successful Japan Post initial public offering has renewed domestic interest in equities and likely increased demand for Japanese equities by investors around the globe.
A Still Market-Friendly Central Bank
Finally, it’s important to put the recent BOJ announcement in context. While the Federal Reserve (Fed) has begun the process of rate normalization, the BOJ remains in a stimulus mode, as it seeks to help the Japanese economy avoid slipping into a recession. This divergence may help support local earnings. In addition, as local inflation remains below the BOJ’s target, the recent announcement expanding the BOJ’s purchasing options may even be a sign of additional supportive measures coming soon out of the central bank.
To be sure, the Japanese market does face potential headwinds, including high public debt and an aging population. In addition, further Chinese yuan devaluation spells trouble for Japanese exporters. However, for the reasons mentioned above, I believe there’s still a very strong case for investing in the Land of the Rising Sun.
That said, investors should consider at least a partial hedge on yen exposure. Amid central bank and growth divergence, the U.S. dollar seems poised to strengthen against the yen over the longer term. ETFs such as the iShares MSCI Japan ETF (EWJ) or the iShares Currency Hedged MSCI Japan ETF (HEWJ) can provide access to the Japanese market.
Heidi Richardson is a Global Investment Strategist at BlackRock. She is also Head of Investment Strategy for U.S. iShares.