Is the depreciation of the Japanese Yen a good thing for Japanese stocks? 152 is the watershed

The Fed's interest rate cut expectations keep falling, the US-Japan interest rate spread is rising, and the USD/JPY exchange rate has hit a new high since 1990 this week, with the rate standing at 154.28 at the time of writing, down 9% from the beginning of the year. Market expectations for the Bank of Japan's intervention are heating up.

Since 2023, the significant depreciation of the yen has boosted Japanese stock pricing, making yen-denominated assets a global value oasis, attracting overseas funds into Japanese stocks. Now the question arises: if the yen continues to depreciate, how much momentum is left for Japanese stocks to rise?

On April 17, a team led by Morgan Stanley analyst Rie Nishihara pointed out in a report that yen depreciation is usually a positive factor for corporate profits. If the yen remains weak and the USD/JPY exchange rate stays around 155, Japanese companies' profit expectations may be revised upward due to exchange rate factors, shifting from the current forecasted decline to growth.

However, Morgan Stanley emphasizes that when the yen exchange rate falls below 152, Japanese stocks start underperforming US stocks, which may have a negative impact on the Japanese stock market. Excessive yen weakness has three major adverse effects on the stock market: impact on the real economy (i.e., consumer spending), exacerbation of the gap between companies and households, export-oriented companies and domestic demand-oriented companies, especially detrimental to small and medium-sized enterprises, and a decrease in returns for overseas investors.

On the same day, Ken Kobayashi, chairman of the Japan Business Federation, stated at a press conference that Japanese financial authorities should consider coordinated intervention in the foreign exchange market with other countries to support the yen. Kobayashi pointed out that due to the yen hitting its lowest level against the US dollar in nearly 34 years, Japanese small and medium-sized enterprises are facing difficulties due to rising costs of imported raw materials.

Yen Weakness Boosts Corporate Performance to Some Extent

Morgan Stanley believes that if inflation remains low, keeping US interest rates high for a long time, this implies that the yen will continue to weaken. On one hand, yen depreciation will reduce export costs for Japanese export-oriented companies such as manufacturing and electronic machinery companies, driving profit growth. Japanese companies' profit expectations may be revised upward due to exchange rate factors:

Looking at the linear relationship between the yen exchange rate and corporate profits, for each percentage point decrease (i.e., depreciation) in the yen exchange rate, the earnings per share (EPS) of companies in the Nikkei 225 Index will improve by a certain percentage.

If the USD/JPY exchange rate actually remains at 155 yen in the 2024 fiscal year, based on the above fixed sensitivity assumption, it is estimated that EPS will receive a boost of about 8% From the perspective of the net profit ranking of Japanese companies listed in 2023, the performance of top Japanese companies is basically related to overseas revenue. Especially in the Japanese automotive industry represented by Toyota, the estimated net profit growth for the 2023 fiscal year is expected to reach 2.9 trillion Japanese yen, accounting for 60% of the net profit growth of Japanese stocks. Taking Toyota as an example, in the 2023 fiscal year (23.04-24.03), with the depreciation of the yen, Toyota is expected to increase its profit by approximately 540 billion yen.

Therefore, Morgan Stanley believes that in the scenario of a long-term weak yen, the stronger U.S. economy will continue to drive the performance of Japanese companies driven by overseas demand, and the performance driven by external demand will outperform companies related to domestic demand in Japan.

Yen exchange rate reaching 152 may be a turning point for Japanese stocks

However, Morgan Stanley emphasizes in the report that if the yen depreciates beyond the USD/JPY exchange rate of 152, it may become a negative factor for the Japanese stock market. If the USD/JPY exchange rate exceeds 157, the import price increase caused by the depreciation of the yen may completely offset the actual wage growth.

The report states that excessive depreciation of the yen may have negative impacts on the Japanese economy and stock market through the following channels: (1) negatively affecting the real economy (households and small and medium-sized enterprises) by suppressing consumption; (2) exacerbating the gap between enterprises and households, export-oriented enterprises and domestic demand-oriented enterprises, especially detrimental to small and medium-sized enterprises; (3) reducing the USD-denominated return on investment for overseas investors:

First, we believe that the real economy will be negatively impacted as rising import prices depress household real income. Based on the sensitivity of import cost inflation to the USD/JPY exchange rate so far, we calculate that 157 yen is the breakeven rate, meaning that the 3.7% basic wage increase decided in spring wage negotiations will be completely offset by import cost inflation (no real wage increase). In other words, if the yen depreciates beyond the USD/JPY exchange rate of 157 yen, real income will not rise with the spring wage agreement, and may even decline, severely dragging down the Japanese economy and stock market.

The second reason is the widening gap between enterprises and households, as well as among enterprises. Excessive yen depreciation benefits export-oriented enterprises but harms households, thereby widening the gap between enterprises and households. We expect the negative impact on small and medium-sized enterprises to be particularly severe, as small and medium-sized enterprises account for 99.7% of the total number of Japanese enterprises and 70% of the workforce. Therefore, if the burden of excessive yen depreciation exacerbates wage pressure, it may drag down the overall economy The third reason is that the US dollar-denominated return on investment for overseas investors in the Japanese stock market has decreased. The market still expects the Japanese yen to appreciate (as of April 17, the market generally expects the USD/JPY exchange rate to be 143 yen by the end of 2024). We believe that most global investors will not invest in the Japanese stock market on a currency-hedged basis. When overseas investors bought a large amount of Japanese stocks in January and February, the USD/JPY exchange rate was 140-150 yen. Due to the depreciation of the yen, the USD-denominated investment return decreased by about 6%