Dear reader
You’ve probably seen the headlines in the financial press about Japan’s equities boom. The Nikkei index keeps hitting record highs after gaining more than 28% last year. At the same time, the country’s economic growth is stagnant. It was only after GDP figures were revised upwards for Q4 of 2023 that Japan officially avoided a technical recession. It’s worth unpacking this apparent contradiction.
The answer lies in a fundamental that is easy to forget: the stock market is not the economy. They are connected in multiple important ways, especially so in the long run. However, nothing prevents them from moving in opposite directions for substantial periods of time.
Stock price drivers
To unpack this, let’s begin with the reasons the Tokyo Stock Exchange (TSE) is thriving. Here are some things you’ll see in the headlines: the yen is relatively cheap at the moment; company earnings are decent; and governance reforms are bearing fruit.
Other likely drivers include a drop in appetite among global investors to hold Chinese assets and the impact of Warren Buffett’s Berkshire Hathaway upping its stake in several pre-eminent Tokyo-listed businesses during 2023.
Now, consider these reasons in light of the economy as a whole. The “connected but different” phenomenon is now clearer. A cheaper local currency has positive and negative impacts on the economy; sentiment shifting away from China is entirely external to Japan’s economy; and the quality of earnings speaks to listed firms only – leaving out large portions of the economy.
Economic drivers
So, you may ask, why is Japan’s economy stalling? GDP contracted in the third quarter of 2023 and initial data showed the same for Q4 of 2023. That indicated a technical recession – that being two consecutive quarters of negative growth. It was only after a belated upward revision in government data of their fourth quarter figures (to a meagre 0.4% annualised growth rate from the prior figure of -0.4%) that the “R word” was avoided.
We can debate many likely reasons. The population is gradually shrinking, which is contributing to headwinds for the manufacturing sector – economies prefer large numbers of young people entering the economy. The labour force is also highly rigid in Japan. Economies tend to prosper with more flexible labour policies.
We could add to this list, but this is not an essay on Japan’s macroeconomic drivers. We’re simply highlighting the overlapping but different forces that chart the respective courses of any economy and a stock market that lives within it.
Again, you’ll note that the chief factors influencing the Japanese economy are related to but separate from those chiefly driving stock prices.
Practical implications
What does this mean for investors? First, it’s a good reminder not to be swayed by a single set of information or a single time period. No sphere of life or investing exists in a vacuum.
More specifically, when building a strategy, investors should remember that economies and stock markets are interrelated but distinct. Evaluating both of these phenomena – and the ways in which they interact – is a must.
If you’re considering injecting Japanese equities (as impacted by economics, of course!) into your portfolio, check out our 1nvest MSCI World Index Feeder ETF.
Regards,
The 1nvest team
