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BlackRock encourages investors to 'redouble their bet' here - "We see an important role for Japanese equities in portfolios and a strong case for closing underweight allocations, due not only to the strategic investment case, but also to their diversification benefits. Japanese equities are relatively uncorrelated to other markets, with sub-50% correlation to most; only Chinese equities provide comparable levels of diversification."

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In its latest market report, BlackRock (NYSE:BLK) analyzes the opportunities that Japan offers for portfolio diversification.

With Japanese inflation now at 2%, is the Bank of Japan (BoJ) moving away from its negative interest rate policy (NIRP) and on a path to normalization compared to other developed market (DM) central banks in Japan now? BlackRock analyzes 3 scenarios:


"Firstly, the growth backdrop appears challenged but not concerning, in our view. Final GDP readings for Q4 were revised higher and survey data and activity indicators, such as PMIs, point to a bottoming out of activity. The wage negotiation progress in March, resulting in a 5.3% rise in wages, suggests that a virtuous cycle of inflation is starting to take hold," the experts note. "Secondly, we believe the BoJ’s shift towards positive policy rates should be taken as a step towards policy normalisation, not a tightening of financial conditions. We see this as a positive: Japan’s financial system is functioning at a level that doesn’t require constant central bank intervention. The policy shift has only been made possible by the hard-won return to inflation: we don’t think the BoJ will risk undoing this, meaning that policy will likely remain relatively accommodative," the managers add. "Thirdly, while the end of yield curve control removes a guaranteed buyer from the bond market, we see potential for institutional investors that historically only bought bonds to rotate into equities as the new policy paradigm takes hold."


"Increased focus on shareholder value is not a short-term trend, in our view: it represents the culmination of a decade of corporate reform driven by the Tokyo Stock Exchange. We think progress on shareholder reforms justifies a higher valuation premium for Japanese equities," they state.

"Meanwhile, the push to encourage domestic investors to participate in the equity market through favourable tax treatment offers another tailwind. With 55% of Japanese household assets in currency and deposits earning little or no interest and only 10% in equities (versus 39% and 20% in the US and eurozone, respectively) this could be a catalyst for a shift in domestic allocations to Japanese equities," the experts note.

"Japan has often been overlooked by international investors in the past. We see reasons for this to change, however, and double down on Japanese equities amid an inflation renaissance, corporate reform and increasing domestic investor participation," says BlackRock.

"Our analysis suggests that closing underweights to Japanese equities can significantly improve the average EMEA portfolio’s risk-return profile. We outline a range of ways to access Japan through index or alpha-seeking exposures," the analysts conclude.

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