Thesis
It is my view that much of the strong gains in the Nikkei were driven by a handful of names, such as; Fujikura (5803.T), Mitsubishi (7011.T), IHI Corp (7013.T), Sony (6857.T) and NEC (6701.T), which I refer to as the Magnificent Asia.
These have all had impressive gains with 3x or 5x appreciation in the past five years alone, which is due to their correlation with the AI / Datacenter bubble. Japan is one of the only markets in Asia that has observed inflows from US institutional investors in recent years.
As the AI craze is potentially reaching a near-term saturation, I see the Japanese Magnificent Asian names as exhausted and representing a promising reversal trade. A correction, as we observed in July 2024, would represent a 50 percent return, relative to the broader N225.
Magnificent Asia vs N225
A few statistics to consider:
Japanese technology stocks, the Magnificent Asia, have benefited from the passive ETF buying by US index funds.
Although Japan N225 has had two strong years, a handful of companies dominate the performance:
Mitsubishi Electronics (7011.T)
The Japan Steel Co (7911.T)
NEC Corp (6701.T)
Fujikara (5803.T)
the top-20 most active stocks in Japan represent 80 percent of turnover; these names have attracted institutional investor flows
Prior to Covid, there was strong correlation between the top-20 and the N225, with only a 10% dispersion for various periods.
the top-5 companies have out-performed the next 15-most active, by over 100 percent in the past two years; this is an unsustainable dispersion
The Nikkei225 appears technically exhausted, having remained in a trading range for over 6 months;
Analysis
Firstly, it should be noted that Japan has been among the best performing global markets over the past fifteen years. Since the lows of the market in 2009, the Nikkei is up over 400 percent, with the majority of those returns occurring from 2021.
Since 2009 - Japan (400%) and India (500%)
Although there are various economists (such as Gerrad Minack) that have highlighted the strength of the Japanese economy in recent years, if you dive a little deeper you’d realize that the stock market’s performance is due to a minority of technology stocks.
The Nikkei225, in particular, is largely driven by the top-20 most active names, which represent well over 80 percent of the index’s total turnover. If we compare the return of the top-15 most active companies to the overall N225, the correlation is nearly 100 percent.
Correlation of Top-15 (excl. of Top-5) versus N225
The extremely strong rally in Japan over the past two years was in fact driven by the performance of 5 stocks (NEC, Mitsubishi, Sony, Hitachi and Fuyikuma), all of which are assumed to benefit from the anticipated growth of AI and Datacenters in the coming years. Their correlation with NVDIA is extremely high.
In the past two years, the top-5 companies in the index have outperformed the N225 by around 80 percent. With the Nikkei rolling-over technically (last peak with June 2024), there is reason to believe that those top-performers have potential for a strong correction.
Top-5 Names (Long) versus N225 (Short)
In the past two years, the top-5 companies in the index have outperformed the N225 by around 80 percent. With the Nikkei rolling-over technically (last peak with June 2024), there is reason to believe that those top-performers have potential for a strong correction.
Fujikura (5803.T) has been the top-performing Japanese stock over the past 2-years with over 700 percent return. As a manufacturer of electronic components, such as fiber optic cables, for data centers and EVs, they have benefitted from the association with NVDIA.
Since they are a mid-capitalization size firm (market cap of $US11 billion), it's reasonable to suggest that their appreciation is justified, given the potential size of the industry would lead to years of rapid growth. Nevertheless, one does need to consider the scale of production and whether the stock’s appreciation is sustainable.
Although I do not anticipate a major market correction in 2025, it is worth noting that Japan and India would be the most affected markets in Asia if we had a sell-off. As in the early phase of the 2020 pandemic, Japan sold off by well over 30 percent in March 2020. Thus, the top-performers in the N225 would be expected to revert significantly in the event of any market distress.
Asian Market Correlation during COVID
If one were inclined to place a concentrated bet, then NEC (6701.T) should catch your attention. has climbed this past month, and appears to have been technically over-bought. In just 18-months, the stock has been on a historic ride.
Considerations
As always, anything is possible; although we’ve had a 15-year bull market in U.S equities to historical valuations , we could certainly see another leg to the rally, which would presumably benefit those markets, particularly India and Japan, that have been on winning streaks.
Similarly, Japan is by no means an “over-weight” market by foreign investors, and could easily see further capital allocation. I’m heavily influenced by Mike Green’s research on the impact of passive investment, where he speculates that we could continue to see very high multipliers (P/Es) due to crowding out of active participants.
This research is purely quantitative based on relative returns, and does not in any way involve a deep dive into the financials of the Japanese technology sector. Perhaps, the AI euphoria will materialize and be the next source of global economic growth; time will tell.