Japan Equities Struggles for Direction as Earnings Season Kicks Off

After surging to record highs in July, the Nikkei 225 is now at a crossroads, leaving investors on edge as earnings season begins. This crucial period will determine whether the Japanese stock market can maintain its gains for the year amidst a strengthening yen, persistent global economic concerns, and political uncertainty.

Adding to investor anxiety is the upcoming change in Japan's political landscape. With Prime Minister Fumio Kishida not seeking re-election as leader of the ruling Liberal Democratic Party (LDP) this month, investors are concerned about potential policy shifts under a new administration and how those shifts might impact the market.

However, overshadowing even these political concerns is the impact of the surging yen, which has gained over 12% against the US dollar in the past three months. This dramatic appreciation threatens to erode exporters' profits, a key driver of the Nikkei's performance.

"A 10% appreciation in the yen should result in a 5-6% underperformance of the Nikkei 225 relative to global equities," warned State Street Global Advisor in a September research note. This warning highlights the challenge facing Japanese companies, particularly those heavily reliant on exports.

The recent upward trajectory of the yen comes as the Bank of Japan (BoJ) signals a shift towards policy normalization. After years of maintaining ultra-low interest rates, the central bank surprised markets in July with a rate hike, fueling speculation of further tightening. This move has narrowed the interest rate differential between Japan and other major economies, diminishing the attractiveness of the yen carry trade and contributing to the currency's recent strength.

Despite these challenges, some market participants remain optimistic. They point to the ongoing corporate governance reforms, which have led to increased shareholder returns through buybacks and higher dividends. Moreover, Japan's economic fundamentals remain solid, with rising wages and robust domestic demand supporting growth.

"We are still positive on Japan structurally," said Alexander Wolf, head of Asia Investment Strategy at JP Morgan Chase, as quoted by Bloomberg. "We see nominal growth and earnings moving higher."

According to a Goldman Sachs index tracking earnings revisions, analysts are generally more optimistic than pessimistic about Japanese company profits, although this varies by industry. While banks are experiencing positive earnings revisions, certain export-dependent sectors like transportation equipment manufacturing are seeing more negative adjustments.

The coming weeks will be crucial for Japanese equities as investors digest corporate earnings reports and assess the full impact of the stronger yen on different sectors. As of the time of writing, Nikkei 225 is trading at 39,178 and is up 17.70% year to date.