Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Ben Powell – Chief Investment Strategist and Carolina Martinez Arevalo – Portfolio Strategist all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Key Points
Room to run: We see Japan stocks climbing higher on robust earnings, corporate reforms and a Bank of Japan likely worried about returning to a chronic deflationary mindset.
Market backdrop: U.S. stocks jumped last week on further tech earnings beats. U.S. Treasury yields ticked down due to markets pricing out some rate cuts.
Week ahead: We’re watching U.S. PCE data out this week for further signs inflation is falling toward 2% this year as we expect. Yet we expect it to rebound beyond 2024.
We believe Japan’s equity rally has room to run – unlike some past false starts. We think both the macro outlook and company-level developments will drive the next leg. The corporate earnings growth we expected since 2023 is playing out. Yet we don’t see markets fully pricing in positive signs like corporate reforms. We think the Bank of Japan will cautiously wind down its ultra-loose monetary policy to avoid disrupting an exit from decades of no inflation. We stay overweight Japan stocks.
Japan’s Nikkei index hit a record high last week for the first time since 1989, when stocks soared to the point the real estate-driven bubble later burst. Those events led to decades of low or no inflation and mostly flat growth. The TOPIX (yellow line in chart) is near its own new record, outperforming most major stock markets in U.S. dollars except the S&P 500 (green line). What’s driving the stock surge? A weak currency has helped boost the value of corporate earnings made abroad. We expect earnings momentum to stay solid. A stabilizing U.S. dollar is not biting Japanese stock returns in the currency as much. And the excess yield investors receive for the risk of holding Japanese stocks over bonds looks attractive. Our positive outlook is about more than a weak yen. Higher inflation is allowing firms to raise prices and protect margins, while wage growth helps to keep fueling consumer spending.
March will be a pivotal month for Japanese markets, with the annual union wage negotiations – likely to shape the inflation outlook – taking place at the same time as the BOJ’s next policy meeting. The negotiations should help signal if inflation has become entrenched. We think the BOJ will end negative interest rates in coming months but will need more evidence of sustained inflation before raising rates further. We don’t see wages growing enough to keep inflation sustainably at the BOJ’s 2% target – and that’s why we don’t think the BOJ will tighten policy as much as markets expect. While not our expectation, we see a risk the BOJ tightens too quickly and too much. That scenario could be more damaging than a slight delay in policy adjustment, in our view, as it could undercut the BOJ’s attempt to end the long stretch of deflation, or no inflation.
Improving profitability
Corporate governance reforms are a key driver of the stock gains. The Tokyo Stock Exchange (TSE) has kept pushing for firms to improve their profitability and return money to shareholders. The TSE has begun disclosing companies that are planning to improve their capital management – a nudge to those that are trading below book value with no improvement plans. Since former Prime Minister Shinzo Abe introduced reforms more than a decade ago, Japanese firms have made some progress on boosting lackluster return on equity – or profitability. That has risen from negative levels in 2010 to 9%, LSEG Datastream data show. It is still half of the U.S. metric, but we think reforms can help narrow the gap. The ongoing earnings season is validating our expectations of robust growth, with TOPIX operating profits up 17% year over year, Bank of America data show.
Alongside these developments, a revamped government tax-free stock investment scheme kicked off this year aiming to stoke domestic investor flows into Japanese stocks. This scheme could facilitate Japanese savers reallocating some savings out of cash and into real assets, including equities, to try to preserve the value of their money in the new inflationary regime.
Our bottom line
We stay overweight Japanese stocks and think they can best their all-time highs. On top of support from the return of mild inflation, we see company-level developments driving the next leg of the rally. We don’t see the BOJ disrupting the optimistic outlook as it likely stays cautious on policy. We see Japanese stocks as attractive given their growth potential.
Market backdrop
The S&P 500 jumped nearly 2% last week, with more tech earnings beats boosting the upward momentum. U.S. tech gains lifted tech stocks globally, and a rally in chipmakers helped Japan’s Nikkei set a record for the first time since 1989. Meanwhile, short- and long-term U.S. Treasury yields fell lower from markets pricing out some Federal Reserve rate cuts this year. We think the positive market sentiment can persist for now as inflation cools and the Fed prepares to cut rates.
This week, we’re closely watching the release of U.S. PCE data – the Federal Reserve’s preferred inflation metric – for signs that inflation is still heading down toward 2% this year as we expect. Falling goods prices have been pushing inflation down, but we see that drag fading in due course. We think inflation will resurge due to stubbornly high services inflation, but we expect that to only become visible later this year.
Week Ahead
Feb. 27: U.S. consumer confidence, durable goods; Japan CPI
Feb. 29: U.S. PCE
March 1: Euro area inflation
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