Nikkei, can it withstand the next interest rate hike?

The Driving Force of Japanese Stocks is Shifting from Earnings to Valuation

In the past two years, the Japanese stock market has seen significant gains, but the current bull market actually began in 2013. Since 2013, the Nikkei 225 has quadrupled from 10,000 points.

What is driving this increase?

When breaking down stock prices into earnings and valuation components,

According to Guohai Securities, since 2023, Japanese stocks have risen by 62%, with an EPS contribution of -4% and a valuation contribution of 104%. The real reason is the uplift in valuation.

Looking solely at earnings,

From 2013 to 2020, the diluted EPS growth rate of Japanese stocks improved overall, but from 2021 to 2024, the EPS growth rate has not significantly increased, instead fluctuating up and down.

In fact, the earnings contribution from some industries mainly comes from overseas income.

In the long term, the overseas sales ratio, overseas production ratio, and export amount of Japanese companies have all been rising. The overseas sales ratio increased from 34.7% in 2010 to 39.10% in 2023; the overseas production ratio rose from 33.3% in 2010 to 35.80% in 2023; and the export amount increased from 67.4 trillion yen in 2010 to 100.9 trillion yen in 2023. In the past two years, the overall resilience of the U.S. economy, along with the widening interest rate differential between the U.S. and Japan, has led to a continuous depreciation of the yen, supporting the external income of Japanese companies.

At the industry level,

In recent years, the pace of overseas expansion for Japanese companies has been led by traditional manufacturing industries such as electronics, precision instruments, and transportation equipment, while industries like chemicals and pharmaceuticals have risen in prominence over the past decade.

As of the end of 2022, the overseas business income ratio of industries such as electronics, chemicals, machinery, transportation equipment, pharmaceuticals, precision instruments, glass and ceramics, and rubber products has exceeded 40%, and these industries have performed well in the bull market.

If we look solely at valuations,

except for the significant increase in valuations in 2020, the trend shows that valuations have been gradually rising since 2022.

The rise in valuations is mainly due to Japan's ultra-loose monetary policy continuing amid the backdrop of overseas interest rate hikes, as well as long-term support from policy levels for low PB companies to increase their stock prices (Japan's special valuation).