The Nikkei 225, a prominent index that covers the top 225 Japanese companies, has recently reached levels not seen since 1989. This achievement has caught the attention of market analysts and investors alike, prompting discussions about the driving factors behind this impressive comeback.
According to Morgan Stanley strategists, the recent surge in the Nikkei 225 should not be compared to a mountain peak where the next step is a descent. They believe that this upward momentum is sustainable and not just a temporary spike. The analysts point out that the profit from the Prime Section-based group of companies has increased by 20% year-over-year, indicating a healthy growth trend. Additionally, Societe Generale’s data reveals that Japan is the only country where earnings per share estimates for this year and the next are actually rising.
What makes this achievement even more remarkable is the absence of a clear driver for profit growth, unlike some other markets that have benefited from technological advancements like artificial intelligence. Despite this, Japanese companies have managed to adapt to the changing economic landscape and implement corporate governance reforms, leading to record-high stock buybacks. Furthermore, the country’s central bank is considering exiting its negative interest-rate regime, which suggests that Japan may finally be escaping deflation.
Interestingly, some of Berkshire Hathaway’s holdings, such as Mitsubishi, Mitsui, Marubeni, and Sumitomo, have been dragging down Japanese profits despite being stellar investments for Warren Buffett’s company. This highlights the complexity of the Japanese market and its unique challenges.
It is important to note that the Nikkei 225, similar to the Dow Jones Industrial Average in the United States, is a price-weighted equity index. This means that stock prices play a significant role in determining the index’s movements. Fast Retailing, the seventh-largest company by market capitalization, holds the largest weight in the index. On the other hand, Toyota Motor, the largest company in terms of market cap, has a lower weight in the Nikkei 225. This quirk of the index construction can lead to unusual results.
While the Nikkei 225 has made an impressive comeback, the broader Topix index is still about 8% away from reaching its peak. For U.S.-based investors, staying at home would have been a more profitable choice over the past 52 weeks, with the S&P 500 seeing a 24% increase compared to the still impressive 20% rise for the iShares MSCI Japan ETF.
However, there are risks associated with investing in Japanese companies. They are highly exposed to both the U.S. and China, with the latter struggling with a debt overhang similar to Japan’s. Moreover, if the Bank of Japan decides to lift interest rates, it could cause the yen to surge in value, potentially making Japanese exporters less competitive.
Despite these risks, the Nikkei 225’s resurgence is a testament to the resilience and adaptability of Japanese companies. With profit growth and positive earnings per share estimates, the index’s rally seems to be more than just a short-term phenomenon. As Japan continues to implement corporate governance reforms and its central bank considers exiting its negative interest-rate regime, investors will be keeping a close eye on the Nikkei 225’s performance in the coming months.
