Is Weaker Yen Still a Boost to Japanese Equities?

Japanese yen is now the weakest since 1972. How does it impact the domestic stock market?

Kate Lin, CAIA 11 May, 2022 | 14:30
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Kate Lin: Welcome to Morningstar. The Japanese yen continues to soften and is now back to where it was in 1972. While a weak Japanese yen is good news for travelers planning their first trip to Japan in more than two years. One would assume that export heavy Japanese equity market will benefit too, right? Michael Makdad, senior equity analyst at Morningstar is here to discuss this with us.

Hi Michael, tell us about the net impacts of a further weakening yen on the earnings of Japanese companies in general.

Michael Makdad: Hi Kate. Yeah. So, I think the U.S. dollar-yen exchange rate, has caught a lot of people's eyes around 130, which is the weakest since 2002. You know, back in 2002, Japan was suffering from the aftermath of the bubble -- in a post-bubble banking crisis. And things were a lot different. And I think people are surprised to see the dollar yen again at 130. But if you look at it, basically on a trade-weighted basis against all currencies, the yen is similar to what we saw in 2007 or 2015. So it's weak, but it's not, in nominal terms, really unprecedented. But what's notable, though, if you're a foreigner traveling to Japan is that because Japan's price inflation has been consistently lower than other countries for more than 20 years now. In real terms, measuring what the yen can buy globally, and what overseas currencies can buy here in Japan, it is the weakest, as you said, since 1972, which was 50 years ago, and when the post-war system of fixed exchange rates broke up, and you know, after that the yen really started to appreciate significantly. So in real terms, actually, the yen is in terms of how much the yen can buy overseas and how much your foreign currency can buy here in Japan. You know, we're basically back to the time of the Nixon shock.

Now, how does that affect the Japanese equities market? I think for many years, you know, weak yen has generally been good for Japanese equities overall. Particularly because of the weight towards exporting sectors. And we still see that a weaker yen is net positive for the market overall. And, you know, the same sectors as before are benefiting and the same ones are hurting. However, compared with, a decade ago, or other times in the past, the benefit has been getting smaller. What's been happening is the sectors that depend on imports, such as retail or utilities or the imports, say oil and gas price in dollars, they continue to depend on those. But the sectors that previously benefited a lot from exports, such as automobiles, they've globalised their production so much that the earnings benefit from a weak yen is still there, but it's less than it used to be. So overall, it's a positive for Japanese share prices in yen terms. But in U.S. dollar terms, I wouldn't necessarily say it's necessarily positive.

Lin: Right. So you mentioned Japan's inflation dynamic is very different to that of other major economies. So do you think the Bank of Japan exiting the ultra-easy monetary policy is a long way off?

Makdad: So Japan's inflation rate is, you know, consumer inflation rate has consistently been been between 2 and 4 percentage points lower than the average for OECD countries. That's the developed countries worldwide for a quarter century now. So 2 to 4 percentage points almost all the time. Since the global financial crisis, it's been more like 2 percentage points lower because the other OECD countries, their inflation rates have come down. And since the financial crisis, they have kept the average inflation near 2%. And Japan's prices have been close to flat. So we were used to this kind of 2%, previously 4%, but roughly 2 percentage point gap. But in the last year, we've had a dramatic change I mean there's currently an 8 percentage point gap in inflation because the OECD average is now 9% and Japan is barely at 1%. It's basically at 1% if we include energy prices, and the core, we still don't have core inflation.

So in that context, you know, given how long the Bank of Japan has struggled in vain to reach its 2% target for CPI inflation. It's pretty clear that Japan is going to keep monetary policy extremely loose, at least for the time being. I think with the coronavirus pandemic receding locally, the labor market here is tight enough that there is economic pressure on corporations to increase wages if prices start to rise. And that's exactly what the Bank of Japan and government have been trying to achieve in order to break Japan out of the deflationary mindset that's lasted for more than a generation. So given that, you know, we finally have an opportunity to kind of break out of that deflationary mindset where consumers don't expect prices to change, but they don't expect their salaries to rise. I think, and given that the Bank of Japan because there's not a lot of inflation yet. The Bank of Japan can tolerate extremely loose monetary policy and that's exactly what they're doing. As for how long that will last? I think it depends on how persistent inflation is global. And it's an open question. But certainly for 2022 and well into 2023, you know, we don't see the tightening of monetary policy here.

Lin: So under this current policy backdrop, are Japanese financial stocks continuing to stay under pressure. And what about Japanese banks?

Makdad: So generally, the Japanese financial stocks, the stocks like Huber have been doing well, some of the Japanese real estate stocks, don't benefit from the higher inflation or higher interest rates. So they haven't been benefiting as much. But the financial stocks have generally done well this year and ended well in 2021. Recently, its especially the Japanese regional banks. And I think it's on speculation that we're going to have an end to this extremely loose monetary policy and that at some point, interest rates might go up, and the very, very thin net interest margins of regional banks and other banks would widen. But I would say that, for me, I don't, I think Japanese bank stocks overall at the current price are fairly priced. And I don't expect a major upward rewriting in price to book or price to earnings multiples from here.

In a more inflationary environment, it also increases pressure on marginal small, small businesses. And that means higher credit costs for banks, and we don't actually see interest rates changing yet. So in terms of the earnings, at this point the share prices have -- some of the share prices have gone up on hopes for higher earnings, we're not going to see the higher earnings. And if anything, we might see pressure on earnings from credit costs. So for banks, overall I'm not really recommending them. But the environment is however good in general for financial stocks, and looks more favourably in terms of sectors on Japanese insurers. They're also reasonably priced. And they may benefit on the property and casualty side from a harder global market for catastrophe risk.

And on the life insurance side for more steepness in the interest rate yield curve. So I like for example, property and casualty insurance company Sompo (8630). And among banks, I think Sumitomo Mitsui Financial Group, SMFG (8316) is priced attractively at the moment because its shares have sold off on a company specific scandal relating to its security insurance business. But I think the long term impact from that scandal will be limited on the bank. So this could be the lower prices from the scandal could be an opportunity to accumulate SMFG.

Lin: Wonderful. Thank you so much, Michael. From Morningstar I'm Kate Lin.

 

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Sompo Holdings Inc5,069.00 JPY1.75Rating
Sumitomo Mitsui Financial Group Inc3,896.00 JPY0.15Rating

About Author

Kate Lin, CAIA

Kate Lin, CAIA  is a Data Journalist for Morningstar Asia, and is based in Hong Kong

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