The Rise of the Nikkei Index - Japan's Miraculous Comeback?

After years of stagnation and slow growth, Japan’s stock market is finally experiencing a resurgence. The Nikkei 225, the stock market index for the Tokyo Stock Exchange, reached record levels not seen since 1989. The index has continued to grow throughout last year into 2025, representing the potential for future growth after an extended period of decline. This signals a potential turning point in Japan’s economy, as rising stock prices are boosting investor confidence, encouraging domestic and international capital to flow into Japanese companies from investors. This can lead to higher profits for firms, and wage growth for Japanese people, which in Japan has remained stagnant since 2000. On a global scale, this growth, if sustained, offers investment opportunities, and strengthens the previously weak Japanese position in a global market. 

For 30 years, the Nikkei 225 provided negative returns. In comparison to the USA’s S&P 500 index’s annual +10%, the Nikkei 225 significantly underperformsInitially experiencing a decade of growth in the 1980s, the asset price bubble of growth burst spectacularly. Within a year, the index lost 38% of its value, and in. 2 years, it had lost another 26%. However, the decline didn’t stop, and the losses kept piling up into the 2010s, where in 2011, the index closed for the year at its lowest year-end value since 1982. This rapid decline was not limited to the Nikkei 225 – it was reflected in Japanese stocks and assets, even including real estate.

The beginning of this downturn, coined as the ‘Lost Decades’ for Japan, was caused by a combination of Japan’s overheating economy, and heightened by a problematic demographic, and weak consumption. In the 1980s, stock market and real estate speculation pushed asset prices to unsustainable levels – at one point, the total value of land in Tokyo was greater than the value of all land in America! However, this would prove disastrous. Japan signed the Plaza Accord with the USA, caused a sharp appreciation of the Japanese Yen, and thus a reduction in export competitiveness. Simultaneously, the Bank of Japan raised interest rates in an attempt to slow inflation. This led investors to panic and flee, causing the stock market to plunge. In this landscape, consumers cut spending and businesses cut their investments, all worsening the crisis. 

The Bank of Japan responded to this by slashing interest rates into the negatives, and introducing Quantitative Easing measures. The Bank of Japan is a central bank, whose objective is to achieve economic growth, while maintaining a lower inflation rate of around 2%. However, these policies were ineffective at achieving these objectives due to the fact that they merely injected money into the system, instead of stimulating investment and spending, as business and workers were more inclined to save. Meanwhile, Japan’s population began to age, soon leading to a demographic crisis as this infirm population led to a decline in the nation’s workforce. The impact of this was compounded by Japan’s risk averse culture, which led to a lack of consumption and innovation, and these factors ultimately resulted in these ‘Lost Decades’. However, after 3 decades of problems for the stock market, 2024 marked an unexpected return to the 1989 highs for the Nikkei 225 index, and a final growth in the Japanese stock market.

The primary reason for the recent stock market growth that began in 2024 is the surge in share buybacks from Japanese companies. Share buybacks are when companies purchase their own outstanding shares on the stock market. This reduces the total number of shares available on the market, driving the value of the remaining shares up. Buybacks do not only grow the value of the stock, they also signal to investors that companies are in possession of excess cash, which grows confidence in that respective company. In Japan, the value of these buybacks during 2024  was ¥18 trillion, around $120 billion USD, with over 1000 different companies participating in this mass phenomenon, such as Toyota, who bought back around $5.14 billion USD of their shares from banks. These buybacks not only drive up share values, they signal shifts in business conditions within Japan. Dividend payouts from companies also increased  - Japanese companies' payout ratio rose to 67.4% last year from 57.1% in 2023. Traditionally, Japanese countries preferred to save extra money they made, as it acted as a buffer against uncertain economic conditions, but the adoption of these practices reflects a trend to a more investor-friendly approach from Japanese firms, as they are now actively looking to return capital to shareholders. 

However, the question of why Japanese companies’ outlooks have changed naturally arises. The answer lies in reforms of corporate governance -  the rules, practices and processes which control a company, balancing the diverging interests of a company’s stakeholders (employees, shareholders, management, customers). Historically, governance practices in Japan have been opaque, with a lack of transparency and a reluctance to provide returns to investors. In order to change this, the Tokyo Stock Exchange established the Council of Experts Concerning the Follow-Up of Market Restructuring. Their aim was to encourage companies to implement more shareholder-friendly practices, such as increasing buybacks and dividend payments, as well as attempting to increase the value of firms. These reforms worked, and significantly contributed to the stock market’s recent upward trajectory.

After a historic year in 2024, the outlook for the Stock Market in Japan is one of both optimism and uncertainty. The Nikkei has the potential for future growth, due to the country’s economic resilience and positive market sentiment. Furthermore, the unpredictability in the USA and China’s markets due to the imminence of a potential trade war means that Japan’s market could be a more stable option for investors during 2025. The Bank of Japan also raised interest rates to 0.5% in early 2025. While this usually slows stock market growth, in Japan, investors saw it as a signal that the economy is recovering. Banks are also benefiting from this raise, as it means they are able to charge more on their loans, earning larger profits.

Overall, the sustainability of this stock market soar remains in question, as the problems of an ageing population remain undealt with by Japan’s government. However, a continuation from 2024 could be a new era of record growth in the stock market. This shows, as always is the case, in investing, nothing is guaranteed.