Japan's Stocks Weather Bumpy Week to Star in Asia Again

I indicated in my story on Monday that there look to be legs to the sustained rally in stocks in Japan. And so it has proved Friday, temporarily answering the question on a report I received Thursday: "Will steep drop in Japanese stock market be temporary or ongoing?"

Temporary looks to be the best bet. Tokyo stocks are the star performers in Asia once again Friday, with the Dow-like Nikkei 225 up 2.0% and the broad-market Topix moving ahead 1.5%. However, that comes after two days when the market moved rapidly lower.

However, we should be cautious about reading too much into a day or two's performance. The point to that report from Naka Matsuzawa, the well-respected chief macro strategist for Japan at Nomura, is that the Tokyo market "plummeted for no discernible reason" on Wednesday, and fell again on Thursday, having also spiked "for no particular reason" earlier in the week, even as markets in other countries were slumping.

Friday is the settlement date for options and futures, which Matsuzawa indicates may have prompted selling earlier this week to lock in profits. He sees no factors that would precipitate a longer-term selloff, while through his macro lens, Japanese equities don't look overpriced for a period of economic recovery.

The Nikkei rose 2.4% for the week. That sustains nine straight weeks of gains, the strongest showing in five years. Foreign investors bought a net US$17.2 billion of Japanese stocks in May and appear to be continuing that trend.

Japan is a beacon of light in a dark period for a reason. Whereas figures released Thursday showed that the Eurozone has entered recession, and the numbers this week out of China indicate severe strain as demand for manufactured exports plummets, Japan has just revised its Q1 economic numbers upwards.

Gross domestic product grew at an annualized pace of 2.7% in Japan for the first three months of the year (or 0.7% q-on-q), better than the initial reading of 1.6% expansion. The previous quarter has also been revised to a very slight 0.1% gain q-on-q. Still, the economy is moving in the right direction, and in fact picking up pace at a time much of the developed world is challenged.

Both private capex and government spending in Japan also got revised upwards in Q1. To see companies investing instead of saving is a sea change, and indicates a concerted push to kick back into gear after the country (still the world's No. 3 economy, let's not forget) recently got rid of the last of its Covid-19 restrictions.

During Japan's three "lost decades," deflation was the rule of thumb, encouraging companies to hoard their cash, and prompting households to put off any major purchases into the future. A car or a fridge or a home could be cheaper next year, so why buy now?

It's devastating for an economy. So the current health of Japan's economy cannot be overstated. The growth is not supercharged but it is very strong by Japan's standards, and at a level that can be sustained.

Tech stocks have driven the rally elsewhere, particularly on U.S. markets, and also catch any bullish mood in Japan. Matsuzawa (who granted is likely to look at things through a Japan-bull prism) believes global stocks "will continue to face corrections through the summer."

Sell in June and go away? Maybe May would have been better. But as a Chinese saying I came across today teaches us, "The best time to plant a tree is 20 years ago. The second-best time is today."

Central banks are never far from this conversation. If the "risk rally" accelerates again in U.S. stocks, the U.S. Federal Reserve may revert to a hawkish stance, which doesn't bode well for tech. Japanese tech stocks, Matsuzawa notes, tend to have a high correlation with U.S. small-to-mid-cap stocks. I can only imagine that correlation stems from risk appetite, and once investors move from U.S. large-caps to riskier U.S. small-caps, they're also willing to consider overseas tech stocks like those in Tokyo.

Sony (T:6758) (SONY) rose 2.1% Friday as a tech bellwether, while chip-and-electronics maker Kyocera (T:6971) (KYOCY) climbed 1.5%.

If and when the Bank of Japan adjusts its superlax monetary policy is also an important consideration, although new BOJ Governor Kazuo Ueda has stressed that the central bank will maintain its easy-money policy for the foreseeable future.

"There's still some distance to sustainably and stably achieve our 2% inflation target," he has just told the Japanese parliament, according to Reuters. "As such, we will patiently maintain our monetary-easing policy."

Japanese companies are starting to adjust prices higher, which helps explain the progress toward that 2% inflation target, which the BOJ has chased for a decade. But Ueda expects inflation to fall below the target later this year, having hit a heady 3.4% for April.

The BOJ is due to meet on monetary policy next Thursday and Friday. But central-bank watchers have pushed back any expectation of change to the July 27-28 meeting at the earliest, with fewer than half the respondents to a Bloomberg survey expecting any change before the meetings in October or even April 2024.

The U.S. Fed will meet on monetary policy first, starting Tuesday. While Japanese stocks have been bumpy, central-bank policy within Japan will seek to maintain conditions that support equity values, so the main consideration will be if the Fed sounds a hawkish tone that could precipitate yen weakness once again. At ¥139 to the U.S. dollar, the Japanese currency has already weakened significantly from its levels at the start of the year, when it strengthened past ¥128. Ueda will face greater calls to change policy if it moves past ¥139.