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Japanese Stock Market Decline: Opportunities for Cross-Border ETFs?

Japan's stock market showed strong performance in the first quarter, with the Nikkei 225 index once breaking through the 41,000 mark. However, its performance in the second quarter was lackluster, becoming one of the global stock markets with the lowest stock price returns, due to the lack of progress in Japan's economic fundamentals. On June 26th, the yen also broke below the 160 mark against the US dollar again, hitting a 34-year low.

The once popular Chinese Nikkei ETF has recently seen a decline in interest, with the premium rate falling below 1.5% this week, which was as high as 20% at the beginning of the year. According to the reporter's statistics, the Nikkei 225 ETF (513880) has seen a回调 of nearly 10.6% from its highest point in the first quarter, underperforming the US stock market and a host of emerging market stock markets. Currently, the TOPIX index is still in the range of 2,700 to 2,800 points, and the Nikkei 225 index is still in the range of 38,000 to 39,000 points, with the former once leading the world with a return of over 40% in a year.

"We have adjusted our stance on the Japanese stock market from overweight to neutral," said Wang Xinjie, Chief Investment Strategist at Standard Chartered Wealth Management in China, to First Financial Daily reporters. Improvements in Japanese corporate governance remain a positive factor, but the continuous downward revision of profit expectations may limit the upside of stock prices. The current stock market momentum is still negative, with a weak price trend compared to other developed market stocks. Regarding the continuously depreciating yen, Standard Chartered expects that as the Federal Reserve is likely to cut interest rates in the fourth quarter and the Bank of Japan is likely to continue raising interest rates, the yen may stabilize.

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Excessive depreciation of the yen raises concerns.

On June 26th, the US dollar/yen broke through the high of 160.17 set on April 29th, rising to 160.87, a 38-year high, which is the lowest level for the yen since 1986.

"Technically, looking at the daily chart, the breakthrough of the US dollar/yen on the 26th is a very complete positive line, closing near the highest point of the day, indicating a strong breakthrough and the possibility of further increases. The complete breakthrough of the previous high point has formed a pattern of higher waves, technically challenging the 163-164 range and opening up new low space. However, at risk levels above 160, the likelihood of intervention by the Bank of Japan increases," said Yang Aozheng, Chief Chinese Market Analyst at FXTM.

Many believe that intervention may not be able to reverse the yen's decline. If the Bank of Japan lacks the courage to fundamentally change its policy, the sharp depreciation of the yen may be the beginning of a new financial storm.

Unlike the past two years, the depreciation of the yen is no longer an absolute tailwind for the Japanese stock market.

"Japan's large stocks, especially the major trading companies, automotive companies, technology companies, etc., all have a global business layout, and their profit sources are global. A weaker yen helps to boost the performance of Japanese stocks," said Wang Xinjie. However, in the short term, excessive depreciation of the yen has also begun to raise concerns.

UBS previously mentioned to reporters that the Bank of Japan is more sensitive to the economic problems that may arise from a sudden excessive depreciation of the yen. For example, imported supply-side inflation may be transmitted to Japan's domestic core inflation. Cost-push inflation is related to the rise in prices of daily life or business function necessities. Since these goods are mostly necessities, their demand is often not affected by price fluctuations, which may bring high input costs to small and medium-sized enterprises, suppress competition and fixed investment, and damage consumer purchasing power.Nomura previously mentioned that the reason for the impressive performance of the Japanese stock market last year was the general belief at the time that, unlike the imported passive inflation of 2022, companies would continue to raise prices in an environment of declining raw material costs starting from 2023, and households would be willing to pay for it. At the same time, companies might start to actively implement wage increases. The increase in corporate prices would lead to higher profits, improved profits would create more room for wage increases, and wage increases would enhance the purchasing power of households, thereby supporting further corporate price increases. A virtuous cycle would gradually take shape.

However, the recent rebound in inflation seems not to have been widely transmitted to wage increases. The wage increases are more prevalent in large enterprises and have not been transmitted to more small and medium-sized enterprises, thus failing to drive the recovery of consumption.

Previously, on June 10th, the Japanese Cabinet Office released the revised GDP data for the first quarter, with the annualized quarter-on-quarter figure adjusted from a decrease of 2.0% to a decrease of 1.8%.

Domestic investors' enthusiasm for cross-border ETFs cools down

With the recent underwhelming performance of the Japanese stock market, Chinese investors' sentiment towards Japanese stocks has also noticeably cooled down.

Last year, the Japanese stock market was as popular as the U.S. stock market, and Chinese domestic cross-border interconnected Nikkei ETFs were also sought after. Corporate governance reforms (Tokyo Stock Exchange's efforts to eliminate companies with a price-to-book ratio below 1) increased the confidence of long-term investors. Amid changes in the geopolitical landscape, the world began to allocate more resources to industries such as Japanese semiconductors.

At the beginning of this year, due to the low fluctuation of A-shares and the strong performance of overseas stock markets, with the Japanese stock market continuously setting new highs, this attracted a large number of Chinese retail investors to buy multiple domestically listed Japanese stock ETFs, with premiums once soaring to 20%, showing a situation where the QD quota was not enough. However, the premium rate has recently fallen to the 1% range.

In addition, many domestic investors bet at the beginning of the year that the yen would rebound significantly against the backdrop of the Bank of Japan's interest rate hikes, but the result was the opposite, which indirectly affected the investment returns of the Japanese stock market.

At present, although governance reforms are still a long-term benefit for the Japanese stock market, macroeconomic fundamentals will still dominate.

Goldman Sachs believes that due to the promotion of several key events, the Japanese stock market may experience some increased volatility in the second half of the year."The market may respond positively to the new financial reports. After the earnings season ends, the market may face pressure due to the summer doldrums, lack of catalysts, and the uncertain outlook of the U.S. presidential election. Political developments in Japan are also a key factor, especially the Liberal Democratic Party's presidential election in September. The market may be under pressure again due to political uncertainty, but we also expect a market rebound by the end of 2024 after the uncertainty subsides."

Although the visibility of the U.S. election results and market reactions to each electoral scenario is still unclear, Goldman Sachs stated that, after the event, the stock market tends to have a strong upward trend as visibility improves. Furthermore, if corporate earnings are strong, the subsequent market feedback may be more positive.

In the future, if Japan's wage growth can continue to rebound, it will also boost market confidence. The institution also mentioned that from the second half of the year, wages will reflect the strong results of the spring labor negotiations, domestic consumption is expected to recover, and tax cuts will also stimulate the economy.

Affected by the suspension of production and shipments of automobile manufacturers (due to non-compliant certification), this situation dragged down GDP during the period from January to March, but it is expected to gradually weaken. Economists predict that consumer growth in the second quarter will turn positive for the first time in a year. At the same time, the willingness of enterprises to invest in capital remains strong. According to the Business Outlook Survey (MOF) released on June 13 for April to June 2024, corporate capital expenditure in the 2024 fiscal year is expected to increase by 12.1% year-on-year. It is expected that from the fall, expectations for the next round of spring labor negotiations will gradually rise, and the strengthened virtuous cycle between wages and prices will be further strengthened.

"Although there may be short-term pressure, we should not ignore the impact of further corporate governance reforms in Japan, which is one of the key drivers of growth in the Japanese stock market," said Wang Xinjie. In terms of medium and long-term investment, the improvement of shareholder returns by companies is crucial, whether it is increasing buybacks or increasing dividends, which is the focus of institutional attention.

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