Notes on a Japanese Record

Editors’ Note: MarketMinder doesn’t make individual security recommendations. Those mentioned below are incidental to the broader theme we wish to highlight.

Japan’s flagship stock index hit an all-time high Thursday, and it was both momentous and meaningless. Momentous, because it completed this index’s round trip from Japan’s 1980s bubble, which peaked on that decade’s last day, finally erasing the crash that followed. Meaningless, because the Nikkei is as broken as America’s Dow Jones Industrial Average and doesn’t represent returns actual investors achieved—especially if those investors were in America. Oh, and like all records, it is backward-looking, saying nothing about what comes next.

Like the Dow, the Nikkei is price-weighted. That is, each constituent’s representation in the index is proportional to its stock price, regardless of its size, leading to some distortions. In one popular example, its largest contributor is Uniqlo parent company Fast Retailing, which comprised 10.9% of the index. Toyota Motors is just 1.4%, despite having a market cap nearly four times Fast’s.^[i] The Nikkei has more than 30 companies, giving it a diversification edge over the Dow, but its weightings are still arbitrary and don’t reflect its constituents’ actual relative importance or clout. The Nikkei also excludes dividends, which is a big blind spot. We can see this courtesy of the market cap-weighted MSCI Japan. Since 1989’s end, it is still down -0.7% in price terms, but with reinvested dividends it is up 66.9%.^[ii] The latter figure is more representative of an investor’s actual experience if they held tight all the way. Japan’s cap-weighted TOPIX, which isn’t yet at all-time highs in price terms, hit record total-return highs in January 2021.^[iii]

Still, with the cap-weighted indexes also flirting with breakeven in price terms, the general return to 1989’s high is worth noting. Yes, it has been a little more than 34 years since Japanese stocks last notched a record, which speaks to how out of whack the 1980s’ Nikkei and Tokyo real estate bubbles were. But it doesn’t mean there has been anything fundamentally terrible about Japan for these 34 years. Bad times and a lost decade or two on the nominal GDP front thanks to ill-advised BoJ policy and an overreliance on supposed fiscal stimulus to paper over the cracks, yes. But it is only a few years longer than the S&P 500 price index took to complete its own round trip from the 1929 crash and Great Depression. And those 34 years included many bull market years and several stretches where Japanese stocks outperformed the rest of the developed world as cyclical tailwinds outweighed the country’s structural issues. Stocks looked forward, not backward.

Stocks aren’t the only Japanese asset back at bubble-era levels. The yen is, too—only where stocks are up, the yen is weak. At 1989’s end it traded at 143.8 to the dollar. Today, it closed at 150.5. In between it was a wild ride, with long stretches of strengthening and weakening that drove policymakers nuts in pretty much equal measure (and made them happy at times, too, depending on their goals and perceptions). But the impact wasn’t just political. It also affected US investors’ returns on Japanese stocks—Americans investing with dollars get the company’s return plus or minus the yen’s movement. When the yen strengthens, it adds to Americans’ returns. When it weakens, it detracts. There has been a lot of volatility on this front for the last 34 years. Yet the big ups and downs mostly evened out, as currencies usually do in the long run. Dollar-based investors had to deal with more volatility, but over time they basically arrived at the same place. This is why we regularly counsel readers not to get hung up on short-term currency swings.

Exhibit 1: Currency Moves Even Out

Source: FactSet, as of 2/22/2024. MSCI Japan Index price returns in yen and dollars, 12/31/1989 – 2/22/2024. Price returns used in lieu of total for daily data availability.

As for what comes next, we suspect it is what always comes next for Japanese stocks: Overall and on average, they participate in global trends—bull and bear markets. Right now the world is in a bull market, and as the MSCI World Index’s second-largest constituent (albeit a very distant second), Japan plays an important role in that. These days, its stocks are at all-time highs despite a three-quarter decline in domestic demand, illustrating the power of global demand and trade to pull Japan’s multinationals along. As markets price in this and an eventual domestic recovery, Japan should keep on trucking with the rest of the world.