Japanese investors could shift from low-yielding bonds to dividend paying stocks as inflation expectations rise, potentially strengthening Japanese equities and related exchange traded funds.
“As the signals are becoming increasingly bearish for its bond market, the trigger for a potential re-rating of of Japan’s equity market may come from bond biased investors at home,” according to a Boost ETP research note. “In seeking equity income as a viable means to hedge against looming inflation risks, they should set in motion a redirection of domestic saving flows away from bonds and into equities.”
Inflation expectations for Japan now exceed the U.S., Boost ETP analysts said. Specifically, Long-term inflation expectations are 2.4%, or 0.4% higher than the U.S.
As inflation rises, a fixed-income investor’s real return diminishes. Japanese investors would have to earn an average annual return of at least 2.4% just to keep up with inflation.
However, Japanese bond yields are extremely low – Japanese investors plowed into bonds during the prolonged deflationary environment to maintain their wealth. Yields on benchmark 10-year Japanese Treasuries is hovering around 1.66%, compared to 10-year U.S. treasury yields at 2.61%.