Economic Research View
Japanese Equity Market Trends and Outlook
Nomura Asset Management Co., Ltd. Published December 7, 2023

Yu Nishikawa, CMA
Senior Quants Analyst, Economic Research GroupOne factor that has contributed to the sustained growth of Japanese stocks since the beginningof the year is the stable performance of value stocks (undervalued stocks). Japanese value stocks,
in particular, have shown a high correlation with long-term US interest rates and have greatly
benefited from the current interest rate environment.
In contrast to Japanese stocks, US value stocks have not received much positive impact fromlong-term US interest rates. This is believed to be due to a few large-cap technology stocks driving
up growth stocks.
Considering the macroeconomic environment, there is a high possibility that long-term US interest
rates will continue to decline. On the other hand, Japanese value stocks could be supported bypolicy measures and positive corporate earnings, suggesting potential for growth in the future.

Figure 1. Value Stock Effects and U.S. Long-term Interest Rates by Region(%)(Value Index / Growth Index)
1.2

1.1

6

Japan (LHF)
US (LHS)

5Europe (LHS)
US10YrGB (RHS)

1.0

40.9

3

↑Value Index > Growth Index↓Value Index < Growth Index

0.8

0.7
Jan-232Mar-23

May-23

Jul-23

Note: Value Index/Growth Index in each region. End of 2022 = 1.
Source: Nomura Asset Management based on Bloomberg data.

Sep-23

Nov-231

Value market in line with US long-term interest rates■

One of the reasons why Japanese stocks have maintained their strong performance since thebeginning of the year is the stable trajectory of value stocks (undervalued stocks).

■

The perspective focusing on value and growth stocks has become highly important in this year's stock
market. This is influenced by the increased volatility in interest rates among major countries. Amongthem, Japanese stocks show a tendency to be more susceptible to the impact of fluctuations in longterm US interest rates when compared to global stocks. When long-term US interest rates rise, valuestocks tend to perform relatively well, while growth stocks tend to perform relatively well when rates
decline. Despite being tied to US interest rates, this correlation is stronger in the Japanese stock
market than in the US stock market (Figure 1).

■

This year, US long-term interest rates have generally been on an upward trend, and Japanese value
stocks have greatly benefited from this trend. As of the end of November, the year-to-date MSCI
indices for Japan and the MSCI World Index were +29% and +18%, respectively, while the respective
value stock indices were +34% and +6%. Against this backdrop, the sustainability of the value investing
trend in the Japanese stock market in the future is likely to be strongly influenced by the interest rateenvironment in the US.

Why US interest rate trends matter■

US long-term interest rates have started to decline since around October, driven by expectations of a
weakening employment environment and a subsequent slowdown in inflation rates. Almost
simultaneously, Japanese value stocks have also hit an apparent ceiling in terms of share price,
following this movement.

■

The strong connection between Japanese value stocks and the interest rate environment in the US
can be attributed to the sector composition of value stocks (Figure 2). Japanese value stocks have ahigher representation of sectors such as financials and automobile, both of which are directly orindirectly influenced by US interest rates.

■

Financial stocks are a sector directly impacted. The increase in long-term interest rates generates a
spread between lending and deposit rates, which leads to significant benefits in terms of performance
improvement. Therefore, financial stocks are likely to be positively affected not only by the long-term
interest rates in the US but also by the rise in long-term interest rates in Japan. On the other hand,automobile stocks are a sector indirectly affected. In recent years, the yen exchange rate against theUS dollar has shown a trend that directly reflects the difference in long-term interest rates between theUS and Japan (Figure 3). In other words, when the difference in long-term interest rates between theUS and Japan increases, it leads to a stronger US dollar and a weaker yen, which especially benefits
automotive stocks with significant earnings improvement effects. From these points, while the sectorsthat become advantageous depending on the trend of long-term interest rates in Japan may differ, interms of value stocks versus growth stocks, value stocks are more likely to become favorable insituations where US long-term interest rates rise.

■On the other hand, many sectors in Japan's growth stocks tend to benefit from declines in long-term
interest rates in the US. Technology stocks, which are representative of growth stocks, generally show
weakness when long-term interest rates rise both domestically and internationally. This is because thelong-term growth expectations embedded in stock prices are larger compared to other sectors, andduring periods of interest rate increases, those expectations are more likely to be reduced. In fact, thisyear's stock market has witnessed multiple instances of technology stocks declining during periods ofrising long-term interest rates in both the US and Japan. Additionally, it is important to note that growthstocks include not only technology stocks but also domestic demand-oriented and defensive stocks

2such as consumer-related stocks. When the interest rate disparity between the US and Japan narrows,
leading to a stronger yen, economically sensitive stocks may falter while domestic demand-orientedand defensive stocks tend to show relatively stronger performance. Therefore, growth stocks have abiased composition towards sectors that tend to be relatively advantageous during periods of declining
long-term interest rates in the US.

Figure 2. Relationship between Interest Rates in the US andJapan and Favorable Sectors

Figure 3. US-Japan Long-term Interest Rate
Differentials and Yen Exchange Rate against US Dollar(%pt)

Japan Long-term Interest Rates

Down

4.5

Up(JPY/USD)
US-Japan Long-term Interest Rates Gap (LHS)160

JPY/USD (RHS)

4.01503.5UpStrong US Dollar /Weak Yen→AutomobileStocks

Financial Stocks

140

3.0ValueStocks

US LongtermInterestRate

2.51302.01201.5Down

High Tech Stocks

Weak US Dollar /Stronger Yen→Consumer
Stocks110

1.0GrowthStocks

100

0.50.0Note: A combination of the direction of long-term interest rates in the US andJapan, which indicate sectors that have favorable tendencies.
Source: Nomura Asset Management based on historical analysis.

1920212223

Note: US-Japan long-term interest rate differentials is based on 10 yeargovernment bonds. As of the end of November 2023.
Source: Nomura Asset Management based on Bloomberg.

Large caps are less relevant in the US■

The lesser degree of correlation between interest rates and US value/growth stock trends comparedto the Japanese stock market can be attributed to the strong resilience of some growth stocks tointerest rate increases. In the case of US stocks, the rise has been led by a few large-cap technology
stocks since the beginning of the year, the majority of which belong to the growth stock category.
These stocks have maintained strong performance even in an unfavorable interest rate environment,
resulting in the sustained dominance of growth stocks. On the other hand, if we look beyond theselarge-cap stocks, we find that mid-cap and small-cap value/growth stocks have shown a certain degreeof correlation with long-term interest rates.

■

Therefore, even in the US stock market, we expect mid-cap and small-cap growth stocks to benefit
from declining long-term interest rates, similar to the Japanese stock market. On the other hand, weexpect large-cap stocks to be influenced primarily by their specific environment, and thus thecorrelation with long-term interest rates will be less significant for the overall US stock market movingforward.

390(Yr)Remaining upside potential for value stocks in Japan■

While the current Japanese stock market environment is becoming increasingly favorable for growthstocks, there is still potential for value stocks to remain resilient. One key factor supporting this is theexpectation that efforts to improve companies with a price-to-book ratio (PBR) below 1, known as PBR
reform, will continue in the future. PBR reform, which started this fiscal year, has provided tailwinds forvalue stocks alongside the favorable interest rate environment. However, while many companies havemade progress in improving their PBR, there are still many with PBR below 1. The TOPIX index has
experienced a 25% increase and eight consecutive months of growth since the beginning of the year,
but the proportion of stocks with PBR below 1 has not significantly improved, decreasing from 49% to
42% during that period (Figure 4). This suggests that many companies in question will continue theirefforts to improve PBR in the future.

■The second point supporting the possibility of a continued value market in Japanese stocks is the solidearnings outlook for value sectors. Growth sectors in US and European stocks, even when consideringthat classification is based on price levels, tend to have higher expected earnings growth rates
compared to value sectors (Figure 5). This indicates that stock prices are generally supported byfundamentals. On the other hand, the relationship of "growth sectors = good earnings" is not commonly
observed in Japanese stocks. From the perspective of value sectors, there are some companies within
the same group that are expected to deliver strong earnings, which suggests that there is still ample
upside potential for value stocks in the future.

■

Furthermore, there is a possibility that long-term interest rates in the US may not decline as much asexpected. Since the beginning of the year, the economic growth outlook in the US has been revised
upward multiple times due to positive economic indicators. As a result, long-term interest rates haveremained at high levels. If the macroeconomic environment in the US continues to stabilize, it could
become more challenging for long-term interest rates to decrease, potentially prolonging the valuemarket trend.

Figure 4. Proportion of Companies with a PBR Below 1

Figure 5. Year-to-date growth rate of TSE Stock Indexes(%)
10080（%）

Value oriented sectors

Growth oriented sectors

12↑ More stocks with PBR < １= Weaker equity market↓ Less stocks with PBR < 1 = Stronger equity maket

10860

640

420020005

1015200(Yr)Note: The data is calculated based on TOPIX constituent stocks until March 2022,
and from April 2022 onwards, it is based on the stocks listed on the Tokyo Stock
Exchange Prime Market. As of the end of November 2023.
Source: Nomura Asset Management based on proprietary database. .

4USEuropeJapan

Note: The data is based on MSCI's forecasted price-to-earnings ratio (PER) byindustry in the aforementioned regions. It categorizes sectors as value or growth
based on whether they are trading at a discount or premium to the marketaverage. The data is then aggregated based on the median of the 12-monthforward earnings growth rate. All calculations are based on values as of the endof October 2023. .
Source: Nomura Asset Management based on FactSet.

*This commentary is based on personal views of the author and does not necessarily represent Nomura AssetManagement house view.
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