Nikkei 30,000 in Sight: Top Themes for Japan’s Stocks in 2021

(Bloomberg) -- With equity prices at the highest in 30 years, fiscal and monetary spigots turned to full and a potential end to the pandemic in the distance, Japanese stocks are enjoying something of a moment.

A market that has been long been ignored and misunderstood is attracting attention from investors at home and abroad as conditions look favorable in 2021. With analysts expecting strong earnings in the forthcoming season, higher dividend payouts than in other markets, and the pandemic handled better than many developed countries, some watchers expect this could be a bumper year for Japan.

“Recession in 2020 was not caused by a financial crisis or bubble collapse like previous downturns,” Masashi Akutsu, chief equity strategist at SMBC Nikko Securities Inc., wrote in the brokerage’s outlook for 2021. “We think the stage is thus set for a strong economic recovery once a vaccine unlocks a return to normal.”

While equity indexes across the globe have been topping new highs, Japan’s remain one stubborn exception with benchmarks still trailing the heights of the bubble era. But this could be the year that the Nikkei 225 starts to test those milestones, with the 30,000 yen mark the first in sight.

The gauge finished above 28,000 for the first time since 1990 on Friday, leaving it needing just a 6.6% gain to hit 30,000. Analysts at Societe Generale wrote in a Jan. 6 note that they expected the benchmark to reach 29,500 by the end of the year, with a 25% chance of their bull scenario lifting the gauge to 31,800.

These are some of the themes to watch for Japan stocks in 2020:

Suga’s Agenda

Backing the surge is a wave of reforms being promoted by Prime Minister Yoshihide Suga, who has made headway on his agenda despite the pandemic. In contrast to his predecessor’s broader but often vague policy goals, Suga has laid out smaller, more precise areas of focus. Those themes likely to continue in 2021 include:

• Digitalization: 2021 will see the launch of Suga’s Digital Agency, an ambitious project to bring Japan’s lumbering and paper-heavy public sector into the digital age. With 100 of its 500 staff set to be recruited from the private sector, as the agency’s goals take shape some companies could see benefits for the likes of NEC Corp., NTT Data Corp., Fujitsu Ltd. and the GMO Internet Inc. group of companies
• Green transition: Suga surprised many when he committed the world’s largest importer of liquid natural gas to become carbon-neutral by 2050. That could result in a $1.8 trillion windfall for the nation’s economy, according to a government report. The transition could be a boon for the likes of liquid hydrogen maker Iwatani Corp., as well as Toyota Motor Corp., which is rolling out hydrogen-fueled cars and also has big hopes for its forthcoming electric vehicles
• Corporate reorganization: Suga has singled out Japan’s regional banks as one area ripe for consolidation, but the push is set to continue beyond that. “With the economy and society starting to change, we think business is going to have to realign more quickly as it too adapts,” according to SMBC Nikko’s Akutsu, “and it already appears to have made a start.”

PM’s Position

But to realize that agenda, Suga will have to stay in power -- a scenario increasingly imperiled by the prime minister’s plummeting support rate.

With Japan facing its toughest moment in the pandemic to date, Suga faces a tricky 2021. Having inherited the remaining year of Abe’s term as leader of the Liberal Democratic Party, Suga needs to retain broad support within the party if he is to remain prime minister.

The approval rate for his cabinet plunged 16 percentage points to 42% in a Nikkei poll at the end of December. Questions will be asked if the rate falls to the traditional danger zone for Japanese leaders.

“We see a possibility that Suga could be ousted even before the next election, should his approval ratings make a sustained fall below 30%,” Fitch said in a Jan. 6 report.

The risk is not just to Suga’s reform agenda, with this period of political stability far from the norm. With no strong contender to replace him, lasting policy changes could be imperiled should Suga be ousted.

“Japan would be at risk of returning to a ‘revolving door’ pattern of leadership changes, which would lead to further domestic political stagnation,” Fitch wrote.

Pandemic, Olympics

The biggest risk to that position comes from the handling of the pandemic. While Japan might be faring better than its Group of Seven peers, the public is unhappy with the handling of the coronavirus -- and Suga has borne the brunt, mostly recently due to an ill-advised steak dinner even as officials warned against such gatherings.

The state of emergency just declared for Tokyo and three nearby areas is set to be lighter than that which devastated the economy in spring last year. But that brings with it its own risks -- that restrictions could end up dragging on for months, impacting public sentiment to spend and dragging down businesses with it.

Looming, too, is the issue of the Tokyo Olympics, set to open in just over six months. Suga reiterated as recently as Monday his determination to hold the games as planned as a mark of humanity’s resilience in the face of the virus, but that determination could be tested amid the current surge. Nonetheless, Japan overcame its first state of emergency much quicker than other nations, and a quick bounce back would boost the Olympics’ chances.

External Factors

Looking beyond the pandemic, some similar macro factors loom. The strengthening yen is already causing nervousness among authorities as it nears 100 to the U.S. dollar. “The main downside risk for Japanese equities is the yen,” Societe Generale wrote. While the correlation with equities has decreased in recent years, “a rapid re-appreciation would cause the correlation to return to higher levels,” according to the report.

Market watchers will also be closely watching to see if the likes of Warren Buffett, the man who made headlines for his investment in Japan in 2020, will be back for more -- and bringing more foreign investment with him. A general shift to value stocks from growth is expected to continue in 2021, which, combined with a focus on economically sensitive names, benefits Japan’s cheaply valued companies above many other markets.

Also ahead lies a review by the Bank of Japan that may see tweaks in its asset purchases, including its buying of exchange-traded funds. The central bank already made its smallest purchase in more than four years this month. The results of the review are expected in March.