What’s behind the strength in Japan’s stock market?

Executive summary:

  • U.S. inflation data from February surprised to the upside 
  • Corporate governance reforms and inflation have helped power the rally in Japanese stocks
  • China announced a consumer goods trade-in program that could boost GDP growth this year

On the latest edition of Market Week in Review, Director and Investment Strategist Alexander Cousley and Product Operations Analyst McKenna Painter discussed the latest U.S. inflation and retail sales reports. They also chatted about the rally in the Japanese equity market and unpacked the latest headlines from China.

U.S. consumer prices rise by more than expected

Painter and Cousley kicked off the latest installment of Market Week in Review by assessing recently released reports on U.S. inflation and retail sales. Cousley noted that the February numbers for the consumer price index (CPI) and producer price index (PPI), published the week of March 11, both surprised slightly to the upside. He said the headline CPI climbed 3.2% in February on a year-over-year basis—a notch higher than consensus expectations, which called for a 3.1% gain—while the headline PPI rose 1.6% on an annualized basis, compared to predictions of a 1.1% increase.

However, there were some encouraging signs within the CPI report, Cousley said, including the fact that the services and shelter components of the index didn’t accelerate further. “Shelter prices, for instance, climbed 0.4% in February—a lower increase than January’s gain of 0.6%,” he explained.

Cousley said the latest CPI readings suggest that the core personal consumption expenditures (PCE) price index—the U.S. Federal Reserve (Fed)’s preferred inflation gauge—rose about 0.32% month-over-month in February. While that number would be a little hotter than the Fed prefers, it would be lower than January’s monthly increase of 0.4%, he pointed out, noting that the official PCE price index report for February will be released March 29.

Turning to retail spending, Cousley said that U.S. retail sales came in softer than expected in February, rising by 0.6%—versus expectations for a 0.8% gain. “While the February numbers fell short of expectations, they’re still well within growth territory,” he remarked.

Overall, Cousley said that while the risk of a U.S. recession still looks elevated, it’s not as high as last year due to the downward trend in inflation. With price pressures easing, he said he expects the Fed to probably start cutting rates in June, noting that the U.S. central bank will very likely keep rates unchanged at 5.25%-5.5% at its upcoming March 19-20 meeting.

Corporate governance reforms help power Japan’s equity market

The conversation shifted to Japan, with Painter noting that the Nikkei 225 Index—the country’s benchmark equity index—hit an all-time record high earlier this month, closing above 40,000. So, what’s behind the index’s recent rise?

Cousley said part of it is due to inflation, which for the first time in 25 years is showing signs of becoming entrenched in Japan’s economy. The other part can be chalked up to corporate governance reforms spearheaded by the Tokyo Stock Exchange (TSE), he said. “The TSE has done lots of work over the past year to encourage companies trading at very discounted valuations—specifically, at price-to-book values below 1.0—to improve their valuations and earnings,” Cousley explained. This has led many Japanese-listed companies to focus more on boosting equity returns, he observed.

Cousley said the Bank of Japan (BoJ) is also likely to announce a few big changes this year as confidence grows that inflation will stay around its 2% target. The first is the expected removal of yield-curve control, which would allow the 10-year government bond to trade freely, he noted. The second change is potentially hiking interest rates into positive territory, Cousley said, noting that the BoJ has held its cash rate at -0.1% since 2016.

Could China’s new trade-in program boost GDP growth?

Painter and Cousley finished with a look at the latest developments from China, where the annual National People’s Congress meeting recently wrapped up. Cousley noted that at the meeting, the government set a 2024 GDP (gross domestic product) growth target of around 5%, which he said was widely expected. Cousley added that some investors had also been anticipating that larger fiscal support measures would be announced, but this didn’t occur. “A look at the budget shows there really isn’t much new spending coming through,” he commented.

However, the week of March 11 did yield some encouraging news, with China’s government unveiling a consumer goods trade-in program that encourages consumers to purchase new cars, among other durable goods. Cousley said the program could potentially boost the country’s GDP by roughly 0.5% to 0.6%, assuming that consumer confidence increases.

“All in all, China’s economy is tracking OK—perhaps a little below trend—but there are some positive signs out there from the policy side, with more likely to come, particularly on the monetary policy side of things,” he concluded.

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