Japan's Market Rally: Is It Sustainable?

For decades, the Japanese stock market was synonymous with stagnation. After the asset bubble burst in 1989, the Nikkei 225 spent 34 years trying to reclaim its all-time high. In early 2024, it finally happened. The index broke through the psychological ceiling of 39,000 and pushed even higher, catching the attention of global investors who had long ignored the region.

This resurgence is not just a momentary spike. It is driven by structural changes in corporate governance, a weak currency boosting exporters, and a renewed interest from foreign institutional investors. If you are looking to diversify your portfolio outside of the United States, understanding the mechanics of this rally is essential.

The Core Drivers of the Resurrection

The revival of Japanese equities is not accidental. It is the result of specific economic forces and regulatory pressures that have finally converged.

Corporate Governance Reforms

The most significant change comes from the Tokyo Stock Exchange (TSE). For years, Japanese companies were notorious for hoarding cash and ignoring shareholder value. This resulted in many companies trading below their book value.

To fix this, the TSE issued a mandate in 2023. They requested that companies trading at a price-to-book (P/B) ratio of less than 1.0x disclose plans to improve their capital efficiency. This “name and shame” strategy worked. Companies began initiating share buybacks and increasing dividends to boost their stock prices.

Major players like Honda and Nissan were among those trading at discounted valuations. As these companies scrambled to comply with TSE requests, their stock prices appreciated, driving the broader index upward.

The “Warren Buffett Seal of Approval”

In 2020, Warren Buffett’s Berkshire Hathaway announced it had acquired 5% stakes in Japan’s five major trading houses: Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo. By 2023, he increased those positions to roughly 9%.

Buffett’s investment signaled to the rest of the world that Japanese stocks were undervalued and offered reliable cash flows. When the world’s most famous value investor pours billions into a specific market, other institutional investors tend to follow. This created a fear of missing out (FOMO) among foreign investors who had been underweight on Japan for years.

The Weak Yen and Exporters

Japan is an export-heavy economy. Companies like Toyota, Sony, and Nintendo earn a significant portion of their revenue in US dollars or Euros. When the Japanese Yen is weak, those foreign earnings translate into more Yen when brought back home.

The Yen has hovered near historic lows, trading around 145 to 155 against the US Dollar for extended periods. This currency disparity has acted as a tailwind for corporate earnings. Toyota, for example, reported record profits recently, largely fueled by the currency exchange advantage.

Is the Rally Sustainable?

The biggest fear for investors is buying at the top. However, comparisons to the 1989 bubble suggest that the current market dynamics are fundamentally different.

Valuation: 1989 vs. Today

When the Nikkei hit its peak in 1989, the market was in a frenzy. The price-to-earnings (P/E) ratio of the index was roughly 60x. That implies investors were paying $60 for every $1 of earnings, a level that is mathematically difficult to sustain.

Today, despite trading at record highs, the Nikkei 225 trades at a forward P/E ratio closer to 15x or 16x. This is comparable to, or even cheaper than, the S&P 500. The rally is supported by actual earnings growth rather than speculative land prices or cheap credit bubbles.

The Return of Inflation

For a generation, Japan fought deflation (falling prices), which kills economic growth. Recently, Japan has finally seen a return of mild inflation. This allows companies to raise prices and increase margins.

Furthermore, the “Shunto” spring wage negotiations in 2024 resulted in the biggest pay hikes for Japanese workers in decades (over 5%). Higher wages usually lead to increased domestic consumption, creating a healthier economic cycle that relies less on exports alone.

How US Investors Can Get Exposure

If you decide that Japan belongs in your portfolio, you do not need to open a brokerage account in Tokyo. There are accessible ways to invest using US dollars.

Exchange Traded Funds (ETFs)

ETFs are the simplest way to buy a basket of Japanese stocks. However, you must choose between “hedged” and “unhedged” funds.

  • iShares MSCI Japan ETF (EWJ): This is the massive, standard option. It gives you broad exposure to Japanese companies. However, it is unhedged. If the Yen continues to fall against the dollar, your returns will be reduced.
  • WisdomTree Japan Hedged Equity Fund (DXJ): This fund focuses on dividend-paying exporters but hedges against currency fluctuations. If the stock market goes up but the Yen goes down, this fund typically outperforms EWJ. In 2023, DXJ significantly outperformed unhedged funds because the Yen was weak.
  • JPMorgan BetaBuilders Japan ETF (BBJP): This is a lower-cost alternative to EWJ for investors who want broad exposure with a lower expense ratio.

American Depositary Receipts (ADRs)

If you prefer picking individual stocks, you can buy ADRs. These are certificates issued by US banks that represent shares in foreign stock. They trade on the NYSE or NASDAQ just like Apple or Microsoft.

  • Toyota Motor Corp ™
  • Sony Group Corp (SONY)
  • Mitsubishi UFJ Financial Group (MUFG)
  • Nintendo (NTDOY)

Buying ADRs allows you to target specific sectors, such as robotics or automotive, rather than buying the whole index.

Risks to Monitor

While the outlook is positive, risks remain. The Bank of Japan (BOJ) recently ended its negative interest rate policy. If they raise interest rates too aggressively, it could strengthen the Yen. While a stronger Yen is good for domestic purchasing power, it hurts the profits of the massive exporters that dominate the Nikkei.

Additionally, Japan faces a severe demographic crisis. With an aging population and a shrinking workforce, the long-term domestic growth potential is naturally capped compared to younger economies like India or the US.

Frequently Asked Questions

Does a weak Yen help or hurt my investment? It depends on how you invest. If you own an unhedged ETF (like EWJ), a weak Yen hurts your returns when converted back to US Dollars. If you own a hedged ETF (like DXJ), the weak Yen does not hurt you, and you capture the stock price growth of the exporters who benefit from that weak currency.

What is the difference between the Nikkei 225 and the TOPIX? The Nikkei 225 is price-weighted (like the Dow Jones), meaning high-priced stocks have more influence. The TOPIX is capitalization-weighted (like the S&P 500), meaning the largest companies by value have the most influence. Many professional investors prefer the TOPIX for a truer picture of the broader market.

Are Japanese dividends taxed differently? Yes. Japan typically withholds roughly 15% of dividends for taxes before the money reaches US investors. However, if you hold these investments in a taxable brokerage account, you can often claim a Foreign Tax Credit on your US tax return to avoid double taxation. This does not usually apply if you hold the assets in an IRA.

What is the “Seven Samurai”? Goldman Sachs coined this term to describe seven highly liquid, well-performing Japanese stocks, similar to the “Magnificent Seven” in the US. The list typically includes Screen Holdings, Advantest, Disco, Tokyo Electron, Toyota, Subaru, and Mitsubishi Corp. These are viewed as the leaders of the current rally.