Can the Nikkei’s record rally in Japanese stocks continue?
After topping bubble-era highs, Goldman Sachs Research says Japanese stocks are poised to rise even higher.
Japan’s Nikkei 225 stock index closed above 40,000 on March 4, setting another record high after climbing last month above levels last seen decades ago. The broader Tokyo Stock Price Index, or TOPIX, has also rallied this year, approaching all-time highs. The Nikkei gained 28% and the TOPIX 25% last year.
Two important structural changes are playing out in the Japanese stock market: The country is shifting to an inflationary economy after years of deflation, and corporate governance reforms are taking root, strategists Kazunori Tatebe and Bruce Kirk write in the team’s report.
“Whereas expectation lifted the market last year, actual progress will likely drive share prices this year,” they write. “Over the past few months, conviction on structural changes has increased and investor confidence appears to be increasing as well.”
How high will Japan’s stock market climb?
Goldman Sachs Research expects the TOPIX to reach 2,900 over the next 12 months (up from their previous 12-month forecast of 2,650). The outlook for Japanese corporate earnings is improving, Tatebe and Kirk write, after a positive surprise in third-quarter earnings and as Japanese companies benefit from a strong US economy and weak yen.
Our strategists forecast cumulative growth in earnings-per-share of 32% over the next three years. “We see further earnings upside if improvement in the global manufacturing cycle continues,” Tatebe and Kirk write.
Tatebe and Kirk note that market concentration has been high, with top performers contributing a larger share of index-level gains than in past rallies. Those big winners include large-cap stocks, such as the TOPIX Core 30, and semiconductor-related equities.
Even so, our strategists say the Japanese market has several tailwinds. After a long period of deflation, a virtuous cycle between wages and prices looks increasingly likely. Recent Bank of Japan communications suggest policymakers have growing confidence that an inflationary environment is being established.
There are signs of wage inflation in Japan
In the runup to this year's shunto spring negotiations — a round of wage talks between unions and management of major firms — there has been a raft of news reports on substantial wage hikes at large companies. Higher wages could boost prices as well.
There are signs the increase in pay is spreading to smaller firms, too. According to a survey of small- and medium-size enterprises released by the Japan Chamber of Commerce and Industry, more than a third of companies are planning to increase wages by at least 3%.
The Tokyo Stock Exchange, meanwhile, remains focused on reform. Through their request in a document titled Action on Cost of Capital-Conscious Management, and various following measures, the exchange has incentivized listed companies to boost valuations. Our strategists say the most important change in the Japanese stock market over the past year is the recognition that companies have to respond to TSE’s requests to implement management that is conscious of share price and cost of capital.
“We see signs that a healthy market environment is being created, in which companies are seen taking action driven by investors interests/concerns and dialogues,” Tatebe and Kirk write. “We believe that the Japanese stock market is in the early stages of a long-running transformation.”
Investors have capacity to buy more Japanese stocks
There’s scope for investors to ramp up purchases of Japanese stocks, according to Goldman Sachs Research.
In Japan, nonfinancial corporations were the largest buyers of cash equities in 2021 and 2022. With governance reforms spurring greater buyback activity, Tatebe and Kirk expect Japanese companies to be major buyers of equities in 2024 as well.
And while they sold Japanese stocks at the start of January, local retail investors have been net buyers of Japanese equities since late January as the market climbs. “We maintain our view that Japanese households are nearing a major turning point in their stance on the equity market amid prolonged inflation.”
Foreign investors may also have capacity to buy more Japanese stocks. GS Prime Services data shows that, on net, hedge funds allocations are slightly underweight versus the MSCI ACWI/World Index. Active mutual funds have had lighter allocations to Japanese equities, compared to benchmark indexes, as well. If the outlook for Japan’s stock market improves further, prompting global funds to shift key index allocations (versus the MSCI ACWI, MSCI World, and MSCI EAFE) from underweight to neutral, there could be $173 billion of potential fund inflows into Japanese stocks.
“We believe foreign investors still have significant capacity to invest in Japan equities,” Tatebe and Kirk write.
This article is being provided for educational purposes only. The information contained in this article does not constitute a recommendation from any Goldman Sachs entity to the recipient, and Goldman Sachs is not providing any financial, economic, legal, investment, accounting, or tax advice through this article or to its recipient. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, express or implied, as to the accuracy or completeness of the statements or any information contained in this article and any liability therefore (including in respect of direct, indirect, or consequential loss or damage) is expressly disclaimed.