The pros weigh up stocks in the US and Japan, with markets touching highs

Investors may be fretting about global economic and geopolitical uncertainty, but US and Japanese stock markets have been powering happily forward. The S&P 500 has hit record new levels this year, and Japan’s Nikkei 225 index has soared to three-decade highs. So, I spoke with some finance pros about how they view these two markets. Here’s what they said.

First, what's driving the new market peaks?

US markets have been largely propelled by the so-called Magnificent Seven group of tech stocks such as Amazon and the AI darling Nvidia, whose stock has tripled over the past year. A more resilient economy and hopes for interest rate cuts have also boosted sentiment.

In Japan, corporate governance reforms – partly aimed at driving higher company returns – have been pivotal. Companies have adopted shareholder-friendly measures, improving disclosures, growing dividends, announcing share buyback programs, and selling off their underperforming assets. Wage growth and the shift from deflation to inflation have also played a big role, as it’s helped drive the country’s consumer sector higher.

What’s more Japan’s recent expansion of the investment benefits that people can get through the Nippon Individual Savings Account is prompting households to invest in stocks, after years of stockpiling cash.

So what do the pros say about these markets?

First, here's what they’ve got to say about Japan.

In Japan, analysts expect financial stocks to perform well, helped by slightly higher interest rates. That follows the Bank of Japan’s historic decision just last month to raise rates just a tad, bringing them out of negative territory.

The country’s small-cap stocks could also see a steady boost, lifted by the improvement in corporate governance. Some of those more petite firms can be had at almost all-time low valuations, says Dan Cartridge, fund manager at Hawksmoor Fund Managers, an attractive prospect, given their decent earnings growth catalysts.

The Hawksmoor Global Opportunities Fund holds M&G Japan Smaller Companies and the Polar Capital Japan Value to get in on the corporate governance play, as well as the investment trust Nippon Active Value Ord.

That said, there are reasons to be a little gunshy about Japan.

Matthew Page is a portfolio manager for the Guinness Global Equity Income fund, which has over 50% exposure to the US, but none to Japan. In other words, he’s a clear skeptic. He said he looks for companies with a consistently high return on capital – and few Japanese firms meet that threshold. And those that do meet it tend to trade at super-high premiums. In other words, Page said: “We think we can find better valuations elsewhere.”

George Lagarias, chief economist at Mazars, is gunshy for another reason. He says the impact of a stronger Japanese yen on earnings could hurt Japanese stocks. That’s because the money made abroad would suddenly not be worth as much once it’s converted and brought back home. So, if the Bank of Japan keeps hiking interest rate hikes, this rally could fizzle.

Of course, there’s a flip side to that coin, notes Cartridge: a stronger yen might hit Japan’s big exporters, but it would likely only strengthen smaller, more domestic-facing firms.

Next, what they’re saying about the US.

Valuations here are lofty – in some cases, super lofty. And that’s got some investing pros – Cartridge included – stepping lightly. Those sky-high valuations will lead to poor returns unless you have “huge upside surprises” in earnings.

For investors, he said, taking profits right now – at all-time highs – isn’t the worst idea, especially when there are so many other global opportunities to exploit.

Lagarias is also cautious about the US. With the economy slowing and with tech trading at a 37 times price-to-earnings (P/E) ratio, he’s not finding any compelling valuations. “This rally doesn’t have legs, and the lack of fundamentals driving it makes investors like me apprehensive,” he said.

But there’s a ton of positive sentiment about this market. And a lot of folks say this tech rally may not be anywhere near the end of its run.

Tech’s stock valuations are high, but they’re not in dot-com bubble territory, Page said. What’s more, the industry’s growth now is being driven by things like semiconductors, which are “far more real and tangible” than the speculation that drove the sector in the 1990s. Still, he’d take a measured approach and wouldn’t leap into the Magnificent Seven stock momentum plays “all guns blazing”.

Frédérique Carrier, head of investment strategy for RBC Wealth Management in the British Isles and Asia, said she is encouraged by the broad performance of US stocks, especially across the industrial, financials, and consumer sectors.

“We are committed to US equities,” she said. “Valuations are elevated but that doesn’t mean they can’t go higher. Even if there was a retrenchment, we don’t think that would be the end of the bull market. The usual precursors of a bear market such as deteriorating market breadth – where fewer stocks experience a price gain – are not there. Having said that, the probability of a shallow US recession remains uncomfortably high, so we will be cautious on stock selection and only focus on high quality.”

She said US investors who have made hay in the past few months could look to cut back on their holdings and take some profit if positions have become outsized. But that doesn’t change the fact that there are still gains to be had.

“You don’t want to be out of the market. It is very difficult to get back in.”

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