Japan's stock market roared back to life in 2023, and investors expect even more gains ahead. How to trade it

Japanese stocks had one of their best years in recent memory, and they could rally even more in 2024. The Nikkei 225 index surged 28% in 2023, its biggest one-year gain since 2013. That outperformed the S & P 500's 24% rally. Japan's stock market benchmark also reached its highest level since 1990. Those gains were led by the combination of a weaker yen and corporate reforms that sparked the most investor optimism on the market in a generation. The market also got a ringing endorsement from billionaire investor Warren Buffett, who raised his stakes in each of the five major Japanese trading houses, and even visited the country to show support for the companies. The firms are Mitsubishi, Mitsui, Itochu, Marubeni and Sumitomo. .N225 ALL mountain Big gains for Nikkei in 2023 That momentum has carried into early 2024. The Nikkei is already up more than 8% year to date, putting it less than 10% below an all-time high set in 1989. What's more, Wall Street sees no signs of Japanese stocks slowing down. “Reminiscent of the large run-up in stocks that we saw in Apr-Jun 2023, Japan equities reignited after the New Year – we wonder if this is Round Two of Japan's equity rally,” BofA's Masashi Akutsu wrote in a Jan. 11 note, noting Japanese stocks are in what appears to be a “deja vu” scenario of their early 2023 surge. Part of what drives Akutsu's thesis are the similar market conditions to this time last year. In early 2023, Japanese stocks surged after the highest Shunto wage hike in 30 years was passed, at above 3% from above 2% the year prior, according to the Japan Times . The Shunto wage hike refers to the pay set after the springtime negotiations between the country's unions and employers. A major increase is notable because it points to a significant shift in Japan, as the country's focus on job security over higher pay was criticized for keeping wage growth low for decades. Stronger wages would also mean companies could attract and retain talent. Already, BofA's Akutsu anticipates that this year's Shunto “looks increasingly likely to be even higher,” as more and more companies announce pay increases. Prime Minister Fumio Kishida also called for greater wage increases this year to keep up with inflation. Corporate earnings and economic growth Another driver for Japanese stocks this year could be strong corporate earnings and economic growth. Nominal gross domestic product in Japan is anticipated to have risen 5.5% in the 2023 fiscal year, and 3% in 2024 . This growth uptrend can serve as a boon for profits in the country — which could lead to a 20%-30% rally for the Japanese stock market this year, according to Horizon Investments chief investment officer Scott Ladner. “It's a story of stagnating earnings in Japan for a very, very long time,” Ladner said. “But now that we've had this shift up in nominal GDP growth, that is a pretty large tailwind towards corporate earnings for Japan, and you actually might start to get earnings going up for the first time in a very long time.” At the same time, Japanese equities are not as cheap as they were in 2023, but they're also not expensive, BofA's Akutsu said. The Nikkei is trading around 19 times forward price to earnings, per FactSet. That's above the 18 multiple it sported a year ago, but it's below the 2021 peak of more than 23. How to get Japan exposure Investors looking for opportunities in Japanese equities could add broad exposure through exchange-traded funds that have attracted significant inflows already this year. The iShares MSCI Japan ETF (EWJ) has attracted roughly $408 million in inflows so far in 2024. The fund has about $15 billion in assets and is up 3% year to date. The WisdomTree Japan Hedged Equity Fund (DXJ) , the currency-hedged fund with $3 billion in assets under management, has attracted about $343 million this year. In 2024, it's higher by more than 8%. However, Glovista's Carlos Asilis cautioned against using currency hedges, as he expects there's a chance the yen could strengthen this year after the U.S. Federal Reserve cuts rates. Bank of America also screened for stocks that could benefit, noting large cap stocks that are quality cyclical names with a return on equity greater than 8% in the following year. Here are some of them. Toyota Motor, which made the list, was recently called a “sleeping giant” by Bernstein. The Wall Street firm said electric vehicle makers should be wary as Toyota enters the fray, indicating its ambitions to be a major player in the space. The U.S. listed shares of the stock are up 8% this year. “While Toyota has previously backed hydrogen and fuel cell technology, its attention has clearly shifted in favour of electric vehicles,” analyst Neil Beveridge wrote in December. “This has enormous implications for almost every company within the EV value chain given the scale of the ambition.” Investors also see broader opportunities in the country as it emerges from a decadeslong stupor. Since the close of last trading day of 1989, the Nikkei has slid roughly 7% over the more than three decades. From that time till now, the S & P 500, in comparison, has climbed more than 1,200%. “It's an under-the-radar opportunity because it just hasn't mattered for the most part, you know, in the better part of a generation. It's kind of been dead money for a very long time. People stop thinking about it. And so, they get lazy, they stop examining it,” Horizon's Ladner said. “And we think that actually, you know, as people wake up to this — what we see as kind of a change in animal spirits is probably the most succinct way to describe it — as they kind of wake up to that, you know, it's a reasonably small market and if there's a lot of money starts flowing in, that could really provide a boost in returns,” he added.