After extreme turbulence hit Japanese equities this week, with the Nikkei Stock Average on Monday suffering its deepest single-day slide on record in yen terms, wealth managers discuss the outlook.

The Japanese equity market has dropped dramatically since the start of August after investors took an extreme risk-off stance on the release of weak US economic indicators suggesting economic slowdown in the US and a sudden appreciation of the Japanese yen. However, Hiroyuki Ueno, chief strategist at Japan’s Sumitomo Mitsui Trust Asset Management (SuMi TRUST), believes this is a temporary market correction.

The sudden appreciation of the yen was triggered by the divergence between Japanese and US monetary policy, as market participants began to see evidence that the US Federal Reserve would cut rates earlier than expected while the Bank of Japan (BOJ) would stick with raising them.

“In the short-term, the market may continue to be swayed by foreign exchange rates and the monetary policy of both Japan and the US. However, in the mid to long-term the market should calm and return to its former upward trend because Japanese corporate earnings remain robust and Japan’s economy as a whole has been able to escape its deflationary cycle and continues to normalise,” Ueno said in a note.

He thinks the market has already priced in expectations that the Fed will slash rates and the BoJ will raise rates, and it is highly unlikely that the huge fluctuations of the Japanese yen against the dollar will continue in the long term.

Japanese economy
“Overall, corporate earnings in Japan are robust, and the Japanese economy is exiting its deflationary cycle; these factors will support the market’s return to an upward trend,” Ueno continued.  Ueno expects that Japanese corporate earnings in the 2024 and 2025 fiscal years will see double digit earnings' growth of Japanese companies. He might make a downward revision on earnings' estimates of exporters in response to the recent sharp yen appreciation. However, he does not expect that he will make big downward revision because exports have reduced their sensitivities of earnings to currencies.

Japanese stocks
In terms of demand for Japanese stocks, Ueno sees many supporting factors. There was a large group of domestic and overseas institutional investors waiting for the best timing to invest in Japanese stocks based on its solid corporate earnings results and good economic data. Overseas investors who were waiting for yen appreciation to slow are taking advantage of the current market volatility to enter the market. 

Overall, Ueno believes that the Japanese market should regain its upwards trend as the foundation of both corporate earnings and the macro economy in Japan remain solid.

The Julius Baer view
His views are echoed by Mark Matthews, head of research Asia at Swiss private bank Julius Baer, who also deems the price action of the past two days in the yen and Japanese financial markets as a panic attack. “There is no need for the Bank of Japan to raise interest rates much more than it has done. After the dust settles, the 520 basis point interest rate differential between the yen and US dollar will once again be the primary arbiter of the pair’s price. We do not see the yen appreciating from here,” Matthews said in a note.

He believes that the strong points of Japan’s equity market remain unchanged. These include wage growth of over 5 per cent this year, after wages rose only 7 per cent over the previous 20 years.

They also include corporate reform, including increased dividend pay-outs and share buy-backs, and brand equity on a scale that exists in no other Asian country. Japan also has a large and liquid market of around 4,000 listed companies, of which hundreds have returns-on-equity in the high teens and above. Earnings' growth for the Nikkei 225 Index is forecast by the consensus to be 7 per cent this year, and 8 per cent next year.

Consequently, Matthews retains his overweight recommendation. In his opinion, the correction is mostly through.

However, Tim Hayes, chief global investment strategist at Ned Davis Research, highlighted this week how the Japanese yen has been the driver of the market’s collapse. He is downgrading Japan from neutral to underweight in his seven-way framework while upgrading his yen position from neutral to bullish.