What’s Behind the Nikkei’s 34-year High and Where Next for Japan?

by | Mar 20, 2024

Written by Richard Aston, portfolio manager of the Chikara Japan Income & Growth Fund and the CC Japan Income & Growth Trust plc

Japanese stocks are on a tear. But as the Nikkei 225 hit a 34-year high last month, opinions around the immediate outlook for the Nikkei index remain split. 

The bulls expect continued gains driven by tailwinds such as comparatively weak global market performance and a shift among consumers towards an inflationary mindset. 

The bears, meanwhile, expect the very trends that pushed Japanese stocks forward to about-face and pull them back. Some see the yen rising significantly against the dollar if the Fed begins cutting interest rates. Others feel a possible rise in Japanese interest rates will plunge thousands of “zombie companies” into deep uncertainty. 

It’s an important consideration for investors setting their near-term expectations. But what we think is even more important is the specific role being played by Japan’s improving corporate governance standards. 

One way or another, the macro-economic considerations above will impact the short-to-medium term performance of the Nikkei 225. The driver that we believe will have by far the biggest influence over the long-term, though, is corporate governance reform. 

These ongoing reforms can have a significant positive impact on valuations and a powerful foundation for long-term growth is in place for the nation’s highest-quality stocks. 

After all, this is a structural trend designed to permanently increase the value Japanese stocks deliver to their shareholders. 

The wheels have been in motion since the introduction of Abenomics in 2012. This led to the creation of corporate governance and stewardship codes that drove consistent improvements in areas like dividends and share buybacks for years. 

Last year, the reforms became truly encompassing when the Tokyo Stock Exchange’s launched its root-to-branch reorganisation of Japan’s stock markets. 

In particular, March 2023 saw the TSE publish a disclosure request focused primarily on enhancing corporate value. After initially focusing on stocks with a price-to-book ratio of less than one, the group is now even urging higher valuation companies to maximise their cost of capital and profitability. 

So far, it’s been a success. 

January figures suggest 40% of stocks listed on the TSE’s Prime segment have made good on its request for corporate governance disclosures – up from 20% in July. Meanwhile, we’ve seen dividends and share buybacks soar, management buyouts hit a new record high, and names like Toyota lead the drive to unwind cross-shareholdings. 

This isn’t lip service – Japanese companies are really following through on their corporate governance pledges. Now the stage is set, the scale and intensity of reform appears to be accelerating. 

For example, we’re already seeing the grassroots of change in Japan’s highly conservative pensions industry. The Government Pension Investment Fund is looking to improve corporate value by increasing its active allocation in stocks and tapping more fund managers for that purpose. 

Likewise, Japan’s Financial Services Agency recently threw its hat into the corporate governance ring when it urged four leading non-life insurers to accelerate the divestment of their cross-shareholders in the face of industry-wide price-fixing scandals. 

Such changes are already driving foreign investment into Japanese stocks towards record highs. That’s likely one of the reasons that Japan’s stock market has performed so well of late. 

As this emphasis on corporate value becomes increasingly substantial and more deeply ingrained, it should continuously deliver value across Japanese markets – regardless of the short-term impact of wider market noise. 

For long-term investors focused on the highest quality stocks, we believe that this is where the real opportunity for outsized returns lies. 

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