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Japanese equities increasingly exhibit low volatility compared to US

20 July 2023

Looking ahead, there are reasons to be optimistic about the performance of Japanese equities.

By Katsunori Ogawa,


There has been lots of positive noise around Japanese equities in recent months, with the Topix climbing to heights not seen in 30 years. But this is not the only reason to be bullish about Japanese stocks: they are also showing decreased volatility when compared with stocks in the US.

Since the 2008 global financial crisis, Japanese equities have struggled. In the immediate aftermath of the crash, the high proportion of manufacturing industries amongst Japanese equites made them particularly susceptible to the global squeeze on consumption. For years, investors avoided Japanese stocks precisely because of their high volatility.

The economic uncertainty wrought by the Covid pandemic marked a reversal in fortunes for Japanese equites. Whilst stocks in the US have increased in volatility – as a result of skyrocketing interest rates and the subsequent rise in the cost of borrowing – the ultra-easy monetary policy pursued by the Bank of Japan has allowed Japanese equities to remain at an even keel whilst share prices steadily increase.

Japanese corporate earnings did not deteriorate as much as feared after the pandemic, as inflation remained mild compared to the US and Europe. The sensitivity of these corporate earnings to exchange rates has also declined.

Historically, Japan's foreign demand-led manufacturing industries suffered because of the strength of the yen. In recent years Japanese companies have increased overseas production with the procurement of foreign currency-denominated parts and materials to reduce vulnerability to fluctuating exchange rates.

Consequently, volatility of corporate earnings in Japan is low. However, ironically foreign production and procurement now means that manufacturers are feeling the effect of a weak yen.

Japanese prime minister Fumio Kishida has indicated his willingness to intervene to support the yen if it plunges to near the $150 level. A stable yen is instrumental in maintaining the low volatility of Japanese stocks and central government’s commitment to maintaining monetary and currency stability fluctuation in share price value as exchange rates peak and trough.

As a result of these factors, a comparison of the Japanese and US stock markets shows a reversal of volatility (annualized standard deviation of daily returns) from 2020. In 2022 this was 15.2% for Topix and 23.2% for the S&P 500. Returns were 3.1% for Topix and -9.6% for the S&P 500, resulting in a Sharpe ratio (return/volatility) of 0.20 for TOPIX and -0.4 for the S&P500.

Looking ahead, there are reasons to be optimistic about the performance of Japanese equities. Volatility is expected to remain subdued, as Bank of Japan Governor Ueda has made clear his commitment to maintaining a low-rates environment. Similarly, corporate earnings will remain resilient to exchange rates.

Whilst there are growing concerns about a recession in the US and with the eurozone having entered a technical recession, Japan's economy is still expected to grow due to rising consumption and the normalization of economic activity following the reopening from Covid-19, which was recent compared to Europe and the US. This will act as a tailwind for corporate earnings, especially in the domestic non-manufacturing industries.

Businesses in the travel and tourism sectors are poised to grow over the coming months, as foreign tourists return to Japan. China’s post-Covid reopening in January of this year is a significant tailwind for this sector, as Chinese tourists accounted for over 30% of all foreign visitors to Japan in 2019. Luxury goods retailers, a mainstay of Japan’s appeal to wealthy Chinese tourists, are especially well-positioned to grow in the near future.

The improving situation around semiconductor supply chains, which was a bottleneck in automobile production last year, will be also be a boon to markets. Toyota Motor are forecasting an increase in production volume of 17% year-on-year in 2023, and similar growth across the sector is expected to lead a strong recovery for the Japanese economy.

The automobile industry is a large employer in Japan, and an upturn in performance for these businesses is likely to create significant employment. This will have a substantial trickle-down effect on the wider economy.

Stocks in Europe and the US show high volatility, exacerbated by widespread economic uncertainty. Whilst US markets have rallied led by a resurgence from tech stocks, there is still significant uncertainty around the growth potential for large-cap equities.

In stark contrast, Japanese stocks with stable corporate earnings and a renewed commitment from Japanese authorities to keeping borrowing costs low are an inviting option for investors seeking steady returns.

Katsunori Ogawa is a portfolio manager of Sakigake High Alpha Strategy. The views expressed above should not be taken as investment advice.

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