A profound impact on global markets! In the era of inflation, "embracing risk," Japanese investors' behavior has undergone a significant transformation

As Japan's economy gradually emerges from deflation and enters an inflationary era, Japanese investors are experiencing an unprecedented adjustment in asset allocation.

Morgan Stanley released a report stating that Japanese household investors are actively taking measures to protect their assets from inflation erosion, reducing their holdings in cash and deposits, and increasing their allocation to stocks and investment trusts. The launch of the new version of NISA (Nippon Individual Savings Account) in 2024 has further accelerated this trend, attracting over 17.4 trillion yen in funds last year, which is 3.3 times that of 2023.

Due to the improvement in interest margins, the Bank of Japan's interest in bond investments is weakening, and its investment focus will shift towards lending. At the same time, insurance companies and pension funds may face competition from households and young investors when allocating assets, prompting them to pay more attention to investments in risk assets.

In terms of assets, Japanese household investors' investments in the Japanese stock market through the NISA program are becoming an important support force for the market. The "buy and hold" strategy of household investors helps provide support during market downturns.

In the bond market, the yield curve of Japanese government bonds is facing structural steepening pressure in the long term. Although the demand for bonds from banks may be limited in the short term, with the adjustments of insurance companies and pension funds, the demand for long-term government bonds will be affected.

"Deflationary Investment" Gradually Abandoned

Morgan Stanley analysts stated in a report on March 11 that prior to the outbreak of COVID-19, the Japanese government repeatedly introduced fiscal stimulus measures to stimulate private demand. Coupled with the increase in social security spending, all of this ultimately translated into huge surpluses in the private non-financial sector. Most of these savings appeared in the form of safe assets such as bank deposits, life insurance, and pension products—in a deflationary environment, these assets were mostly invested in Japanese government bonds.

As Japan's economy continued to stagnate, there were hardly any attractive investment opportunities in the domestic market, and the huge trade surplus was ultimately reinvested in overseas assets. Financial institutions also favored overseas assets in search of attractive returns.

However, as the economy reopened, major supply-demand imbalances intensified inflationary pressures, forcing many major central banks around the world to rapidly raise interest rates consecutively.

Japan is no exception. After implementing a negative interest rate policy for eight years, the Bank of Japan finally terminated the policy in March 2024. Long-term inflation expectations have also risen significantly, increasing by more than 2 percentage points for an extended period alongside the sharp rise in the consumer price index.

Against this backdrop, Japanese investors are re-evaluating their investment strategies, which will have a profound impact on the performance of various assets.

Household Sector: From Cash is King to Embracing Risk

As inflation expectations rise, Japanese households are accelerating their shift from cash and deposits to long-term investment products and risk assets In the past, Japanese households primarily allocated their assets in cash and deposits, with a low risk appetite. However, under inflationary pressure, Japanese households are actively seeking more effective ways to preserve and increase the value of their assets.

To cope with inflation, households of all ages in Japan are gradually reducing their holdings of cash and deposits, turning instead to long-term investment products or risk assets. This shift is particularly evident among younger groups, who are less constrained by deflationary thinking and are more inclined to pursue long-term investment returns.

At the same time, the attractiveness of the Japanese stock market is also increasing. The new NISA (Small Investment Tax Exemption Plan) set to launch in 2024 is promoting household investment in the Japanese stock market. Morgan Stanley estimates that investments in Japanese stocks through the new NISA alone will bring in at least 63 trillion yen.

Institutional Investors: Strategic Shift from Fixed Income to Risk Assets

The investment behavior of Japanese institutional investors is also undergoing significant changes.

Morgan Stanley analysts indicate that the core profitability of banks has improved significantly, reducing the need to take on risks through securities investment channels. The trading volume of yen and non-yen bonds has decreased significantly, while allocations to investment trust products have increased.

Life insurance companies have seen a decline in insurance reserves since 2021, and as households shift towards investment trusts and other risk assets, the securities investment capacity of life insurance companies has been affected. Many households have canceled foreign currency-denominated products in favor of pursuing higher returns through investment trusts and other channels.

In terms of pensions, the funding adequacy ratio for corporate defined benefit pensions exceeds 100%, which may lead to a reduction in risk exposure and a rebalancing from stocks to bonds. Public pensions are expected to maintain relative stability in their portfolios.

Morgan Stanley analyst Koichi Sugisaki stated:

"In a world of positive interest rates, the priority of bond investments for deposit-taking institutions has significantly decreased, as they can now obtain sufficient interest income from their core business."

Structural Forces Reshaping Asset Prices

These changes will have multifaceted impacts on the market. In the Japanese stock market, individual investors have become a key support force during market downturns, similar to the role of the Bank of Japan, helping to drive momentum when Japanese stocks rise.

For the Japanese government bond market, in the long term, the yield curve faces structural steepening pressure. Banks with ample deposits may continue to favor short- to medium-term government bonds, while demand for long-term government bonds may weaken. Private pensions may be more inclined towards risk assets rather than capital-protected products.

In the yen foreign exchange market, given that Japanese households hold approximately $15 trillion in assets, the ongoing outflow to foreign assets (through investment trusts) to hedge against inflation may lead to a long-term structural weakening of the yen. In the non-yen bond market, U.S. agency mortgage-backed securities (MBS) may benefit from demand from the Bank of Japan, while insurance companies will increase foreign exchange hedging. Japanese investors have cumulatively purchased $1.69 trillion in non-yen bonds since 2004. Among these, yen-denominated bonds account for 69%, while euros only account for 12%. U.S. Treasury bonds are the biggest beneficiaries, accounting for $746 billion.

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