Here’s a look at why Japan is garnering investors’ attention after decades of sluggish growth and what you should watch out for when investing in the Japanese market.

The Japanese resurgence

First, an overhaul of corporate governance rules has been the key catalyst for the stratospheric rise.

In March, the Tokyo Stock Exchange (TSE) had urged companies to boost capital efficiency, notably on companies with low price-to-book ratios (of less than 1). In response to TSE, there was a stream of companies expanding shareholder returns, by distributing record dividends and/or share buybacks. The broadening engagement and positive corporate reforms have made Japanese shares more attractive to investors.

Second, while inflation has been a bugbear for many countries, the return of inflation is welcome in Japan after years of fighting low inflation or even deflation.  While deflation leads companies and consumers to delay investments and purchases, moderate inflation can spur confidence in companies to invest for the future, and encourage consumers to spend. 

Despite the return of inflation, the Bank of Japan (BoJ) has kept an accommodative monetary policy, consequently making the Japanese yen relatively weaker. This is typically positive for Japanese corporates because it boosts the value of repatriated overseas profits – where most of the listed companies have significant overseas exposure.

Finally, spending has also surged. Japan is one of the last few countries to lift COVID-19 restrictions and has seen a strong rebound in tourism, surpassing even pre-pandemic levels. Japanese corporates are ramping up on capital expenditure to expand their businesses while the largest wage increase in 30 years for employees would likely boost consumer spending.

These structural changes/reforms and improving fundamentals are stoking investors’ appetites for Japanese stocks.

Taking the plunge

With Japan’s stock market seemingly entering a new era, should you also put your money in the East Asian nation?

After all, investing in one of the world’s biggest economies presents plenty of opportunities, with Japan’s stock market comprising of global titans from car manufacturers, consumer electronics to well-known clothing brands. Investing in Japanese stocks may be a good option to diversify your portfolio. 

But one should always exercise extra caution when investing abroad. For one thing, such investments expose you to foreign exchange risks, suggesting the possibility that an investment may decrease due to currency fluctuations. There are also additional custody fees to take note of.

Nevertheless, with Japan’s inflation above the central bank’s target, there is also a risk to its easy monetary outlook. For instance, In July, the BoJ unexpectedly widened its yield curve control, raising doubt about whether a change is on the horizon.

It is thus imperative that you have a good understanding of the Japanese market and keep close tabs on its developments. In addition, given the sharp run-up in prices, Japan’s stock market is showing signs of exuberance, notably with valuations now trading above historical averages.

Investors should focus on companies with strong fundamentals and a good track record of corporate governance to ride the wave of these positive changes. This means doing thorough research before taking the plunge abroad.

As Buffett once said, “Risk comes from not knowing what you are doing.” Being prepared so you know what to expect will set you up for success.