While the Federal Reserve (Fed) will likely begin raising rates later this year, the Bank of Japan (BOJ) remains in easing mode and is planning to continue to expand its balance sheet, providing a potential tailwind to the country’s stocks.
Increased equity buying by institutions
The Japanese market has benefited from the GPIF and other institutional buyers increasing their investments in Japanese equities. While the GPIF rebalance is almost complete—the fund will likely reach its target allocation of 25 percent this month-other pension funds could also increase their equity exposure, given that the GPIF rotation contributed to record returns for the fund. In addition to pension funds, Japan Post—Japan’s largest bank, insurance company and employer—may also shift some of its assets to stocks from bonds.
Underpinning the above case for Japan is the country’s changing macroeconomic picture under the reform policies of Prime Minister Abe, known as Abenomics. Now into in its third full year, Abenomics consists of a three-pronged (or three-“arrowed”) approach: aggressive monetary policy to end deflation, expansionary fiscal policy to give a boost to the economy and finally, a pro-growth strategy to enhance conditions for longer-term growth and improve corporate competitiveness. Examples of this third arrow include the GPIF’s bigger allocation to equities and reforms to encourage shareholder-friendly corporate activity.
So, while Japanese equities have done well lately, it’s important to remember that their performance has been driven by the results of Abenomics, namely quality earnings growth and shareholder-friendly policies, rather than just multiple expansion.
The Japanese market does face potential headwinds, including high public debt and an aging and shrinking population. In addition, there are a number of scenarios that could derail the rally in Japan, such as a significant global slowdown and inflation stemming from a declining yen. But these scenarios seem unlikely today. Given all this, Japan may remain a stock market worth considering.
Exchange traded funds (ETFs) such as the iShares MSCI Japan ETF (EWJ) or the iShares Currency Hedged MSCI Japan ETF (HEWJ) can provide access to the Japan market.
Heidi Richardson is a Global Investment Strategist at BlackRock. She is also Head of Investment Strategy for U.S. iShares.
* Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.