Japan, the relationship between the yen and the stock market is changing

The performance of the Japanese stock market has tended to be inversely correlated with fluctuations in the Japanese currency: when the yen appreciates, the stock market tends to lose ground and vice versa. As reported on financialounge.com, according to Ben Rodriguez, multi-asset manager at Columbia Threadneedle Investment, this relationship may no longer be so clear-cut due to the Japanese government's economic policies aimed at improving corporate profitability. For this reason, analysts are becoming increasingly bullish on the Japanese economy as they see the possibility of a change in the traditional inverse relationship between the value of the yen and corporate profits.

Companies: increasing profitability

Rodriguez stresses that the analysis is primarily based on improving corporate governance, a long-standing goal, and increasing shareholder attention to Japanese companies. Following the real estate bubble and stock market crisis of the 1990s, Japan undertook a series of reform initiatives to improve corporate profitability and capital efficiency. Rodriguez notes that the steady rise in return on equity (RoE), a key indicator of return on equity for the top Topix 500 companies, suggests that these programmes are beginning to bear fruit. Companies are making significant efforts to improve capital efficiency and increase returns to shareholders.

Importance of policy reforms for the economy

The improvement in Japanese corporate earnings has been greatly influenced by recent policy reforms, which were also implemented in April last year. A key aspect of these measures is the requirement for companies listed on the Tokyo Stock Exchange to publicly disclose their risk management plans and strategies for promoting growth, always with a view to profitability. In particular, companies with a price-to-value ratio (P/VC) of less than 1 will come under close scrutiny and will be required to 'accurately identify' their costs and improve capital efficiency. Since the announcement of these reforms at the end of July, Japanese equities have gained almost 16%, outperforming global equities in local currency terms by 5%.

Domestic and international factors at play

In addition to the long-term impetus from the reforms, there are also medium-term supportive factors, both domestic and international. Domestically, consumer confidence has recovered after the pandemic-related restrictions that will last until 2022, household budgets are strong and there is room for further improvement before domestic consumption reaches pre-Shock levels. Japan's tourism sector also has ample room for growth before returning to 2019 levels.

Conclusions

The manager of Columbia Threadneedle Investment concludes that, from an international perspective, it is possible that we are approaching a period where we will see a change in the traditional inverse correlation between the value of the yen and Japanese corporate earnings. Rising interest rates in the major developed economies, with the exception of the Bank of Japan, have affected global growth prospects and expectations for Japanese cyclical earnings, and have also led to a depreciation of the yen through the interest rate differential. From now on, however, with the expected gradual narrowing of interest rate differentials on both sides and a possible peak in the global economic cycle, we could see an appreciation of the yen and an increase in Japanese corporate earnings.

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