The yen is strengthening, but foreign investors are staying bullish on Japanese equities
A falling yen helped boost Japanese stocks to record levels this year, but overseas investors think there are still opportunities in those equities even as the currency begins to strengthen. For most of this year, the weak yen was a major bull case argument for foreign investors looking at the Japanese stock markets. For instance, it enhanced corporate results for companies like Toyota Motor . For investors holding Japanese assets denominated in yen, the decline of the currency led to the value of their gains increasing. And for a long period, a weakening yen seemed like a safe trade. From January 2021 to June 2024, the yen depreciated by 55% against the dollar to cross the 161 mark this June, its weakest level since 1986. However, the Bank of Japan’s decision to raise interest rates in late July — thereby reducing the interest rate differential with the U.S. — led to the currency beginning to finally strengthen against the dollar. Meanwhile, the Nikkei 225 index fell more than 12% on Aug. 5 , its worst day since “Black Monday” of 1987. The yen was last trading at around 144 against the greenback. JPY= YTD mountain Yen against the dollar in 2024 “Yes, there is [now] volatility, but we’re not hiding from it. In fact, we’re embracing it and using the liquidity the market’s giving us to scale into positions,” said Janus Henderson portfolio manager Julian McManus. McManus isn’t the only one who increased his exposure into the Japanese market following the early August sell-off. In the same week, Japan equity funds notched their third-highest inflow so far this year, according to EPFR . Stronger yen on earnings The downside impact of an appreciating yen on Japanese corporate earnings will be limited assuming global growth remains stable, according to Jefferies. In the last four periods of “decisive” yen strength since 1995, the yen has strengthened an average 25% against the dollar, per Jefferies strategist Shrikant Kale. With this in mind, Kale estimates a yen appreciation to around 120 versus the dollar will lead to earnings cuts of 10% in a soft landing scenario. In this case, the market will correct in a range between 9% and 14% in yen terms, but actually rise 5% to 9% on a dollar basis, he added. Bank of America also thinks that in spite of the risk to companies’ earnings posed by a strengthening yen, there are still enough savings from the yen having traded around the 156 level versus the dollar from April to June this year. To this point, Janus Henderson’s McManus agrees that the strengthening yen is not a cause of concern for corporate earnings. Most companies were using the 145 yen-to-dollar level as the basis for the budgets throughout this year, he noted, rather than the higher levels. As a result, even with the yen trading significantly weaker from its 2024 highs, the annual average would still be weaker than the average exchange rate assumed by companies. “In Japan, we see above-consensus earnings growth of 10-11%, support by nominal reflation and corporate reform, which we don’t think are disrupted by recent volatility,” Morgan Stanley strategist Daniel Blake wrote in a note on Aug. 20. Helping dollar-based investors The seachange in the yen will benefit foreign investors. Earlier in the year, even as the Nikkei 225 climbed to record levels, the weakening yen hurt stock prices when denominated by the dollar. Before the yen started to strengthen, “Japanese investors could benefit because their lives and portfolios are denominated in yen. But for a foreign investor, it was more challenging because you couldn’t convert the value of your Japanese stocks in yen terms into rising value of Japanese stocks in let’s call it U.S. dollar terms,” said Peter Perkins, partner at Macro Research Board Partners. As a result, an appreciating yen will help overseas investors realize gains from the Japanese market as it continues its rebound. The Nikkei 225 has recovered from the Aug. 5 sell-off and is now up nearly 15% year to date. .N225 YTD mountain Nikkei 225 in 2024 Historical trends support the case for Japan outperformance in periods of yen strength, Jefferies said. In the last four cycles of yen strength, the MSCI Japan index fell more than 7% in yen terms but gained 24% on a dollar basis, according to the firm — and even outperformed the MSCI All Country World Index by 24%. “This suggests that, if the cycle is heading towards [a] period of persistent yen strength, global investors should overweight Japan,” Jefferies said. Bank of America forecasts the stock market making a “full recovery” by late September or October, and estimates the market to trade near its March highs by the end of the year. In spite of the rise in volatility for the yen, the currency still remains relatively inexpensive, Perkins noted. The yen traded at 103 against the dollar before the Federal Reserve began hiking rates and the market-perceived fair value for the yen was at the 120 level, he added. Investors should look to gradually gain exposure now, rather than hold out in hopes of greater stability in the yen, Perkins said. “Of course, the move from 163 to 147 is a reminder that things can change relatively quickly. … Gradually increasing exposure and taking advantage of any weakness we think would be the right thing to do,” he said. To be sure, exogenous shocks or threats to either the Japanese economy or global growth could threaten the outlook, Perkins added. “That can happen, but we don’t see any basis for believing that that is going to happen,” he said. “It’s kind of a wild card, and you can’t run investment strategy on constantly worrying about wild cards.”
