The return of a miracle: how to make money on the Japanese market, which has recovered after 35 years

It took the Japanese stock market more than a third of a century to return to the level when the bubble burst that marked the end of the Japanese economic miracle. But now a new phase has begun for the market, based on more classical investment approaches. It offers hope that the three lost decades are in the past.

It is traditionally believed that in the long term, stocks grow. This is the basis for long-term strategies, including the principle of passive investing: even if the market is falling now, you just need to follow the index, because within a few years it will still resume growth and then turn out to be in the plus. For example, after the Internet bubble of the 1990s, the American Nasdaq Composite fell by 75% in less than three years, and returned to its peak 15 years later.

During the Great Depression, the Dow Jones Index also fell for three years, then began to recover and returned to its peak after 25 years.

But Japan's Nikkei 225 broke those anti-records. The Japanese economic miracle took the index to the top in 1989: it reached almost 39,000 points in the last days of the year.

But then the giant bubble in the stock and real estate markets burst, and Japan ended up losing three decades of economic growth.

Why did it take her so long to recover? The reason is the mistakes of the authorities. After the collapse, they tightened monetary policy, but at the same time they did not dare to close the banks and companies on the verge of bankruptcy, which turned into "zombies" and suppressed economic and investment activity for decades. Deflationary expectations strengthened in the country and a long period of deflation began.

As a result, from peak to bottom, the Nikkei 225 fell for 20 years, losing about 82%. In 2009-2012, it fluctuated at its lowest levels, and only then did it begin to recover. The index reached its pre-crisis maximum only last year - after almost 35 years, after which it remained at this level for more than a year.

Years of slow reforms and successes in fighting deflation, which after much effort have started to show recently, have laid good foundations for continued growth, analysts said.

This year, the market was first hit by US President Donald Trump's trade war, which caused the Nikkei to plummet to 31,000 points in early April. But then Trump postponed the imposition of duties, and in July Tokyo reached a trade agreement with Washington, achieving a reduction in the duty rate from 25% to 15%. As a result, the Nikkei rose 46% to 45,355 points from its April low.

The Bank of Japan has been trying to stimulate inflation in unconventional ways for about two decades: it was the first to use quantitative easing (buying up assets in the market, with exchange-traded funds and real estate funds subsequently added to government bonds) and the last to abandon negative interest rates (last year).

In 2013, the Bank of Japan set an inflation target of 2%. And while other leading central banks have been cutting interest rates in recent years, it has been raising them as it has achieved and even exceeded its target. Core inflation, which excludes energy and food prices, hit a more than 40-year high of 4.2% in January 2023. It was 3.1% in July this year and 2.7% in August.

Rising prices and wages, which have not been seen for decades, are changing the investment preferences of the Japanese. Until now, bonds and monetary instruments were the main ways to save.

Financial assets of households at the end of 2024 exceeded $14 trillion, half of them accounted for cash (their purchasing power in a situation of deflation was growing, not declining, as traditionally happens in inflation) or deposits, notes the Financial Times.

But "if people think deflation is over," significant funds could move into the equity market, Joshua Crabb, director of Asia-Pacific equities at management firm Robeco, told the newspaper.

"Will there be a massive jump in [economic] growth in Japan? No, it won't. Will there be a change at the asset allocation level because inflation is coming back after such a long time? Yes, absolutely," he added.

Neil Newman, Japan strategist at Astris Advisory, is already seeing an influx of money from investors: "Both foreign and domestic institutional and retail investors have now entered the market."

The influx of Japanese investors should in the long term support the enthusiasm of foreign investors - they, according to Bruce Kirk, Japan strategist at Goldman Sachs, have largely provided the rally this year. By the end of August, foreigners had invested $35.7 billion in the Japanese market, allowing the Topix index, which includes shares of all companies traded in the country, to exceed 3,000 points for the first time in history.

The actions of foreign investors are partly explained by the desire to diversify investments, reducing their presence in the US market, where Trump's policy provoked a decline in the dollar. It is seen by many as a long-term trend.

The yen, for its part, has strengthened nearly 5% since the beginning of the year.

It can, however, be a significant risk factor. Since the mid-1990s, the yen has been the most popular currency for carry trades, where an investor borrows money in the currency of a country with low interest rates and invests it in higher-yielding assets in other currencies.

The sharp appreciation of the yen has triggered a tsunami in global markets several times, most recently in August 2024. Then, from early July to early August, the yen appreciated by 14%, generating losses on curry trades, and investors rushed to close positions that exceeded $1 trillion. As a result, the Nikkei 225 collapsed by 12.4% on August 5, and then a wave of sell-offs swept the world.

However, as the interest rate differential between Japan and other developed countries shrinks, yields and thus the volume of carry trades should decline, and with them the risk of such sharp jumps.

Another factor that can support long-term growth is long-standing corporate reforms, notes investment portal Finimize.

Companies have restructured to simplify business structures and free up capital. This is what Nissan did, for example, at the request of Renault after the companies entered into an alliance in 1999. Also under pressure from regulators, they got rid of divisions that might have been in a half-dead state for decades after the crisis of the early 1990s and started to be more responsible to shareholders.

Corporate governance reforms began in 2012, but have picked up significantly in the last couple of years when the Tokyo Stock Exchange began publicly shaming those who failed to meet regulatory requirements in 2023, Charlie Linton, Ninety One's Asia-Pacific portfolio manager, explained to the FT.

He said this has freed up hidden shareholder value in a number of companies and the potential for further appreciation in the local market remains.

"The trend towards better corporate governance will continue in the long term," says Oleg Kapinos, global strategy director at Asset Management One, a Japanese management company.

Inflation in Japan has been at elevated levels for the longest period since the early 1980s, says Jon Treacy, publisher of investment newsletter Fuller Treacy Money. After the economy was stuck in deflationary stagnation, the acceleration in inflation has proved to be a temporary phenomenon each time. That's causing the Bank of Japan to act more cautiously now to avoid ruining the much-coveted price growth, but also to keep it from spiraling out of control.

In this situation, the stock market serves as a hedge against inflation, and this partly explains its current rise, says Treacy: "It is also made attractive by low valuations compared to Wall Street, and the 50 percent devaluation of the yen since 2016 serves as an additional incentive."

Investors see good opportunities for earnings in the sector of industrial companies. In particular, shares of Mitsubishi Heavy Industries, the country's largest defense contractor, have grown by more than 70% since the beginning of the year on expectations of increased military spending on the part of the government and management optimization on the part of the company's management. The company's average target price for the stock implies a 4.8% rise to the closing price on Sept. 26. Out of 15 analysts, 10 recommend buying the company's securities and two more give an "above market" recommendation, which corresponds to a "buy" recommendation. Three of them recommend to "hold" the stock.

Nintendo shares (plus 40% YTD) are steadily rising after the release of the new version of the Switch game console, notes Treacy. The average target price from analysts suggests the stock is up 6% from the closing price on September 26. Of the 25 analysts, 13 of them recommend buying Nintendo shares, two have an "above market" recommendation, and eight have a "hold" recommendation. One analyst each has a "below market" and "sell" recommendation.

Shares of investment firm SoftBank broke through the 11,000-12,000 yen price level in early August, which they have failed three times in the past seven years, and soared to nearly 20,000 yen. The average target price from analysts, based on Yahoo Finance data, is 15,376 yen, down from current values. But of the 19 analysts, 12 of them give a "buy" recommendation on the investment company's securities, one gives an "above market" recommendation and five others give a "hold" recommendation. One has a "below market" recommendation.

This article was AI-translated and verified by a human editor