International investors are likely to increase their exposure to Japanese equities or, indeed, consider including them in their portfolios for the first time this year and beyond.
The reason is that the world’s third-largest economy is experiencing inflation that reached a four-decade high in February and continues to run hot.
Sharp price gains are rarely desirable, but Japan is an exception after bouts of deflation since the late 1980s and early 1990s.
Japan has been grappling with a persistent problem of low inflation and deflation for several decades for four main reasons.
First, it has an aging population and a declining birth rate, which has led to a shrinking workforce and reduced consumer spending. With fewer people entering the workforce and spending less, there is lower demand for goods and services, resulting in stagnant prices.
Second, Japan has experienced prolonged periods of economic stagnation, characterized by sluggish growth and weak consumer and business spending. This has limited the potential for inflationary pressures to build up.
Third, the country has one of the highest debt-to-GDP ratios among developed countries. To manage this debt burden, the government has implemented accommodative monetary policies, including low interest rates and quantitative easing. While these policies aimed to stimulate economic growth, they have not translated into significant inflationary pressures.
And fourth, Japan has faced structural challenges in its economy, such as excess capacity in certain industries, weak productivity growth, and limited wage increases. These factors have contributed to a lack of upward pressure on prices.
Economic recovery
However, in more recent times, as the economic recovery continued amid supportive monetary and fiscal policies and a surge in tourism, inflation has surged.
For this reason, cash is no longer king as the rising prices are eroding Japanese investors’ purchasing power.
As such, they’re increasingly looking for alternatives, and we expect Japanese equities are going to be the go-to as a way to preserve or even increase the real value of their investments.
Equities are often seen as a potential hedge against inflation. When prices rise, the value of a company’s revenue and earnings may increase, leading to higher stock prices.
Should Japanese investors pile into the Tokyo and Osaka exchanges, equity values will naturally increase, and this will pique the interest of international investors looking to further diversify their portfolios to seize opportunities and mitigate risk.
Japan experienced a prolonged period of economic stagnation in the 1990s and 2000s, often referred to as the Lost Decades. This era was characterized by low economic growth, deflation, and a weak stock market. The negative perception of Japan’s economy during this time seriously deterred international investors from considering Japanese equities.
In addition, historically, Japan’s corporate governance practices and transparency standards were considered relatively weak compared with other developed economies. This lack of transparency and shareholder-friendly practices made some would-be overseas investors cautious about investing in Japanese companies.
Plus, of course, equities in Japan have not consistently outperformed other global equity markets in recent years.
But as values are likely to rise as investors shed cash and fixed-income investments because of rising inflation, this trend for overlooking Japanese stocks will be reversed.
Nigel Green is founder and CEO of deVere Group. Follow him on Twitter @nigeljgreen.