Japanese equities have long been overlooked by many global investors. But they may be on the verge of a comeback as the worldwide economic recovery gathers pace and the high-flying stocks that drove the global market rally in 2020 show signs of fatigue.

Even as the COVID-19 vaccine rollout has improved the outlook for the global economy, many investors remain reluctant about putting more money into equities. For some, there’s a nagging concern that the market may have already priced in good times ahead. Yet there are still laggards that are well positioned to benefit from a broadening in the market’s recovery. Japanese companies, particularly value stocks, offer just such characteristics after underperforming for most of the past decade (Display).

Relative performance of Japanese stocks versus global stocks, and value stocks versus growth stocks over the past decade.

After years of underperformance, Japanese stocks are attractively priced versus global peers, with the MSCI Japan Index trading at a forward-earnings multiple of 16.1% at the end of May, a 22.0% discount to the MSCI World Index. And in a sign of the pent-up energy in the more undervalued parts of the Japanese market, the MSCI Japan Value Index has been off to a roaring start in 2021, gaining 15.6% through May 31, compared with 0.2% for its growth counterpart.

Broadening Equity Rally to Support Japanese Market

Why have Japanese stocks—and value stocks globally—fallen behind so much? The main reasons, in our view, are twofold. Prior to the pandemic, Japanese stocks were shunned, mainly over concerns about an economic downturn after one of the longest periods of expansion in the post-World War II era. Japanese companies are perceived to be vulnerable to slowdowns in their export markets, and many value stocks are in cyclical industries.

Then, when the pandemic began, the Japanese market and value stocks worldwide fell further behind due to investors’ focus on a narrow set of “quality growth” stocks—such as the global internet giants—whose gains accounted for a lion’s share of the global market rally in 2020.