In late June, Japan’s benchmark Nikkei 225 index closed at its highest level since March 2000. While Japanese stocks are down a bit from then, the Japanese market, as measured by the MSCI Japan index, is still up roughly 15 percent this year, outperforming the broader MSCI ACWI index global market, according to mid-July Bloomberg data.*
Japanese stocks’ strong performance has prompted some market watchers to question whether there’s still a case for adding exposure to the Land of the Rising Sun. They’re worried that the market will soon lose steam, as one of the major recent buyers of Japanese stocks-the Government Pension Investment Fund (GPIF)—is set to hit its target equity allocation as soon as this month.
I still see opportunity in the Japanese market for the following key reasons.
Attractive Valuations
While Japanese valuations have increased over the past year, they remain more attractive than those in the rest of the developed world and the broader market, on both a price-to-earnings (P/E) and price-to-book (P/B) basis, according to 7/12/15 Bloomberg data. In fact, in mid-July, according to Bloomberg data, the P/B for Japan was still half that of the U.S. It’s also worth noting that Japanese stocks remain inexpensive even after outpacing their major developed market counterparts year-to-date due to strong earnings momentum, according to Bloomberg data.
Strong Earnings Momentum
As my colleagues and I write in Investment Directions, Japan’s economy, while certainly not a locomotive, has managed to pull out of a shallow and brief recession, and it’s beginning to show signs of benefiting from a weaker yen. This is helping Japanese companies continue to improve their profitability. Last year’s conservative estimates and corporate governance reform are also helping to improve the earnings picture.
Improving return on equity (ROE)
Japanese corporations are putting more emphasis on shareholder value and are increasingly returning cash to shareholders in the form of dividends and share repurchases. As of July 12, ROE in Japan was up 30 percent from 2012, according to Bloomberg data. Looking forward, as Japanese companies can potentially continue to improve their profitability, ROE may increase further this year and next.
A market-friendly central bank