Nikkei 225 index hits 5-month high in ‘catch-up’ rally

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Japan’s Nikkei 225 index burst through the 30,000-point mark in opening trading in Tokyo on Tuesday, hitting a five-month high in a return of “animal spirits” as investors prepared for a ruling party leadership contest and national election.

The gains come days after the broader Topix, which has underperformed for much of the year, hit a 30-year high, building on a market rally that began late last month. Fund managers said Tokyo had experienced an “underweight squeeze” before global funds rushed to readjust their positions.

The sharp rise in the Nikkei means the index, which remains highly influential over the mood of Japanese retail investors, is up more than 1,200 points or about 4.2 per cent, since Friday morning, when prime minister Yoshihide Suga announced his resignation. 

The market is rife with speculation that Suga’s successor could unveil a stimulus package, possibly as much as ¥30tn ($273bn), to rescue the ruling Liberal Democratic party from potential humiliation at a general election scheduled before the end of November.

Favourites to follow Suga’s one-year tenure include Fumio Kishida, a former foreign and defence minister and a top LDP figure who told Japanese media that he would have the Bank of Japan maintain both its 2 per cent inflation target and its expansive stimulus programme. 

Elections for the lower house of Japan’s Diet have a record of generating market rallies regardless of the policy issues of the day, according to analysts at Nomura.

In the seven weeks before the five lower house elections since 2005, foreign investors, who own about one-third of the Japanese market and account for most of daily trading volumes, have been net buyers of an average of ¥3.1tn. That equates to an average rise of about 1,500 points on the Nikkei index, according to Nomura’s chief equity strategist, Yunosuke Ikeda. 

But market analysts, including Ikeda, cautioned against attributing the current rally solely to the leadership shake-up. Global funds were rapidly adjusting portfolios after an extended period of underweighting the world’s third-biggest economy, they said.

The rebound for Japanese equities also followed their dismal underperformance in 2020, during which the Topix rose less than 5 per cent. A global pandemic relief rally drove the S&P 500 to gains of more than three times that figure.

“It’s very important to realise that it is not just election fever,” said Ikeda. “It is a catch-up process for Japanese stocks after a long period of undervaluation against other markets.”

The underrating of Japanese markets was justified by a number of factors, he said, including the Suga administration’s perceived mishandling of the Covid-19 crisis and a tumbling approval rating that appeared to derail any prospect of reform.

The Tokyo Olympics, held without live spectators and underlining the collapse of Japan’s inbound tourism, did little to raise the mood.

Foreign investors were net sellers of Japanese equities between May and July, contributing to the underperformance of the country’s benchmark indices against global counterparts.

A particularly significant gap had opened up between the price-to-earnings ratio of the Japanese market and the European benchmarks, strategists said. 

But the market mood switched sharply over the past 10 days as Covid-19 infection numbers in Tokyo began to fall and attention shifted to what a new leader might do to boost the economy.

Global fund managers who had been heavily underweight on Japan in recent months were caught out by the sharpness of the reversal and were turning buyers, said John Vail, chief global strategist at Nikko Asset Management.