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Nikkei 225 index hits a 34-year high! A comprehensive guide to investment opportunities. Which stocks are included? How to invest?
Thirty years is a cycle.
The Japanese stock market fell for 20 years and then took 15 years to return to its peak.
In February 2024, the Japanese stock market reached a 34-year high, and the Nikkei 225 Index is just a step away from 0.04 million points.
With the consecutive highs of the Japanese stock market, investors are turning their attention to investment opportunities in the Japanese stock market. The best way to understand the local stock market is to analyze its market indices, just like investing in the US stock market, where you must know the S&P 500 Index and the NASDAQ Index.
The Japanese stock market has multiple market indices, among which the most famous are the Nikkei 225 Index and the Tokyo Stock Exchange Index.
The Nikkei 225 Index is the oldest stock index in Japan and serves as a barometer for the Japanese stock market. It is inevitably the focus of analysis for investors.
This article will help everyone to have a deeper understanding of the Nikkei 225 Index, including its industry distribution and constituent stocks, historical trends, underlying logic of the rise, and how to invest.
What is the Nikkei 225 Index?
The Nikkei 225 Index, or the Nikkei Stock Average in full, is one of the most representative stock indices in the Japanese stock market.
The index is compiled by Nikkei Inc., and was first published on September 7, 1970, using the price-weighted average method for calculation.
The Nikkei 225 Index tracks the 225 most representative stocks listed on the Tokyo Stock Exchange, including global renowned companies such as Fast Retailing, the parent company of Uniqlo, and Toyota Motor.
The Nikkei 225 Index has a history of over 70 years (started compilation on September 7, 1950, and the index value can be traced back to May 16, 1949). It is the most well-known stock price index in Japan, and whenever the Japanese stock market conditions are reported in the media such as television or newspapers, this index will be used (major international media also generally publish this index).
Selection rules for the Nikkei 225 Index
1. Selection rule: Liquidity
Among the listed companies on the Tokyo Stock Exchange, 225 stocks with the most active trading volume and highest market liquidity are selected. This selection rule based on liquidity aims to maintain the long-term continuity of the index and to reflect changes in industry structure.
2. Adjustment frequency: Twice a year
In order for the index to reflect the stock market situation in a timely manner, the index will regularly replace the constituent stocks to achieve survival of the fittest. Generally, there are regular adjustments and ad hoc adjustments.
Regular adjustments are made every six months, replacing low liquidity stocks with high liquidity stocks. The adjustments are usually implemented at the beginning of April and October, with the adjustment plan being announced in advance.
Ad hoc adjustments are made if any stocks are delisted or merged, and new stocks that meet the criteria are selected to ensure that there are 225 constituent stocks in the index.
3. Price Weighting: The higher the stock price, the higher the weight.
After selecting the stocks, each stock is assigned a weight based on price weighting.
The specific calculation method is as follows:
Nikkei Average Stock Price Index = Sum of adjusted stock prices of constituent stocks (225) / Divisor
Adjusted stock price = Stock market price (yen) x Stock price conversion factor
The so-called price weighted index means that the higher the price of a single stock, the higher its weight in the index and the greater its impact on the index.
Actually, the price weighted index is a relatively old weighting method. The Dow Jones Industrial Average in the US is calculated using the price weighted method. However, this method has some flaws, as the impact of large cap stocks on the index may not necessarily be higher than that of small cap stocks.
For example, currently the largest component stock in the Nikkei 225 index is Fast Retailing, the parent company of Uniqlo, with a weight of nearly 11%. However, if ranked by market capitalization, Fast Retailing is not the company with the highest market cap in the Japanese stock market.
Therefore, to match the scale of companies, the more popular weighting method nowadays is market capitalization weighting, which assigns weights based on market cap. The larger the market cap, the higher the weight in the index and the greater the impact on the index. The Tokyo Stock Exchange uses the market capitalization weighting method.
Therefore, just from the perspective of weighting method, you can simply consider the Nikkei 225 Index as the equivalent of the Dow Jones Industrial Average in the Japanese stock market, and the Tokyo Stock Exchange Index as the equivalent of the S&P 500 Index in the Japanese stock market.
Which stocks are included?
If you want to know which industries and stocks are the hottest in the Japanese stock market, the simplest way is to look at the Nikkei 225 Index, because the component stocks in the Nikkei 225 Index are the most actively traded stocks.
1. Industry Distribution
The components of the Nikkei 225 Index include the stocks of 225 representative listed companies on the Tokyo Stock Exchange. These companies cover various important sectors of the Japanese economy, including technology, consumer, manufacturing, and more.
However, with the development of technology, the industry structure of the index has undergone a dramatic change. As of January 31, 2024, the Nikkei 225 Index is mainly weighted towards the technology and consumer sectors, with weights of 49.1% and 23.76% respectively, totaling 72.9%.
In other words, investing in the Nikkei 225 or the Japanese economy means investing in the technology and consumer sectors.
2. Top 10 Weighted Stocks
The top 10 holdings of the Nikkei 225 Index account for approximately 40% of the total, with the largest holding being Uniqlo's parent company, Fast Retailing (10.94%), followed by Tokyo Electron (7.67%), Advantest (4.28%), and Softbank Group (3.56%).
In addition, some well-known components include Sony, Nintendo, Toyota Motor, Honda Motor, and others, these companies have important positions in the Japanese and global markets.
You may not be familiar with the top 10 components, as 7 of the 10 stocks are technology stocks. Here are some brief introductions:
Fast Retailing (9983.JP): Fast Retailing is a Japanese clothing company that operates the casual clothing retail chain Uniqlo, known for its reasonably priced high-quality functional clothing. Its founder, Tadashi Yanai, and his family are currently the richest people in Japan.
Tokyo Electron (8035.JP): Tokyo Electron is a major supplier of semiconductor manufacturing equipment. Customers include logic, wafer fabrication, and memory chip manufacturers, such as Intel, TSMC, Micron, and Samsung.
Advantest (6857.JP): Advantest is a company based in Japan that produces and sells semiconductor test systems and mechatronics integration products for testing and measurement, medical care, nanotechnology, and other end markets.
SoftBank Group (9984.JP): SoftBank, founded by former Japanese richest man Masayoshi Son, is well known for its investments in e-commerce company Alibaba and semiconductor company ARM.
KDDI (9433.JP): KDDI is the second largest wireless network operator in Japan (31% market share), the largest pay TV operator (53% market share), and the second largest fiber-to-the-home broadband provider (12% market share).
Shin-Etsu Chemical Co., Ltd. (4063.JP): Shin-Etsu Chemical is a Japanese company mainly engaged in the chemical industry. The company operates in six business areas, including PVC, specialty chemicals, silicones, semiconductor silicon, electronics and functional materials, and diversified businesses.
Daikin Industries, Ltd. (6367.JP): Daikin Industries is one of the world's largest heating, ventilation, and air conditioning (HVAC) companies. North America, Japan, China, and Europe are Daikin's four major markets, accounting for 24.1%, 23.7%, 16.7%, and 14.5% of the revenue for the fiscal year 2018 respectively.
TDK Corporation (6762.JP): TDK is the world's first commercial supplier of ferrite core, and one of the leading global suppliers of passive components for automobiles and polymer lithium-ion batteries for smart phones.
Fanuc Corporation (6954.JP): Fanuc provides factory automation products worldwide, including industrial robots, computer numerical controls, and compact machining centers (Robodrills).
Terumo (4543.JP) is a medical device and pharmaceutical company in Japan. The company has three main businesses: blood management, cardiovascular, and comprehensive hospitals.
Historical trend of the Nikkei 225 index
The Nikkei index can be traced back to as early as 1949, with a history of over 70 years, witnessing multiple economic changes in Japan.
Starting in the 1960s, during Japan's period of high economic growth, the Nikkei 225 index also rose. In the 1980s, due to low interest rates triggering an economic bubble, the stock index accelerated. On December 29, 1989, the Nikkei 225 index closed at 38,915.87 points, setting a historical record. At that time, the entire world marveled at the miracle created by the Japanese financial market.
However, in the 1990s, the bursting of the Japanese economic bubble, along with the impact of declining land prices, stock prices, and economic deterioration, led to the bankruptcy of banks and securities companies. The Nikkei 225 index plummeted by 50%, resulting in a sideways pattern throughout the entire 1990s.
In the 20's, with multiple terrorist attacks in the United States and the 2008 subprime crisis, the Nikkei 225 index suffered heavy blows and hit rock bottom in 2009. From 1990 to 2010, the Nikkei index declined for almost 20 years, a period known as the "Lost 20 Years of the Japanese Economy".
In the 21's, Japan experienced a major earthquake, the Fukushima nuclear disaster, and a tsunami in 2011, causing another economic decline. It wasn't until Shinzo Abe's second term as Prime Minister in 2012, when the Japanese government proposed the 'Three Arrows of Abenomics', that Japan's economy began to improve, leading to a continuous rebound in Japanese stocks. Over the 15 years after the lowest point in 2009, the Nikkei index grew nearly 4.5 times.
In the past year, the Japanese stock market has seen rapid growth. In February 2024, the Nikkei 225 index surpassed 40,000 points, hitting a historical high after 34 years. As of February 27, 2024, the Nikkei 225 index has risen by 17.6%.
What is the underlying logic behind the rise of the Nikkei 225 index?
Many investors may be curious about the underlying logic behind the 10-year bull market in the Japanese stock market.
In fact, there are definitely many reasons, but they can be simply summarized into two aspects, fundamental and monetary. Fundamentals refer to whether companies are becoming more profitable, while monetary refers to increasing number of people buying.
1. Fundamentals: Corporate profits are increasing. According to statistics from China International Capital Corporation, from 2012 to 2023, the CAGR of the Nikkei index was 11.2%, while the CAGR of EPS (earnings per share) of constituent stocks was 9.3%, indicating that EPS contributed the most to the increase. Why can Japanese companies make more and more money? There are two main reasons:
As the saying goes, when you buy stocks, you are buying a company. If the company is becoming more profitable, then the company will also become more valuable.
According to CICC analysis, the 10-year bull market in the Japanese stock market is mainly driven by the growth of corporate profits, with EPS (earnings per share) as a specific indicator. According to their statistics, from the end of 2012 to the end of 2023, the CAGR of the Nikkei 225 index itself was 11.2%, and the CAGR of EPS was 9.3%.
The reason why Japanese companies are becoming more profitable is because they started actively expanding overseas in the 1990s. By 2024, about 70% of the overall revenue of Japanese listed companies comes from overseas, and the global economy is the underlying logic behind the performance of Japanese companies.
2. Funding: Foreign capital flows into the Japanese market.
The stock market can also be seen as a commodity market. If the supply of commodities is insufficient, prices will rise. Similarly, if more and more funds start buying Japanese stocks, it may push the Japanese stock market higher.
According to CICC data, from 2024 to mid-February, foreign investors accumulated net purchases of approximately 3.5 trillion yen of Japanese stocks, during which the Nikkei 225 index rose by about 15%. They believe that foreign capital has been actively buying Japanese stocks for three reasons: the Buffett effect, Japan's exit from deflation, and the positive impact of Nikkei 225 index.
What are the reasons why Buffett is bullish on Japanese stocks?
Starting in 2020, Buffett began buying Japanese stocks and continuously increasing his holdings:
In 2020, Berkshire Hathaway announced for the first time that it had bought more than 5% of the shares of Japan's five major trading companies.
In April 2023, Berkshire Hathaway increased its stake in the five major trading companies to more than 7.4%, becoming the largest investor outside the United States;
In June 2023, Berkshire Hathaway announced that it had increased its average stake in Japan's five major trading companies to more than 8.5%.
In the latest 2024 shareholder letter, Buffett stated that he will continue to hold long-term positions in Japan's five major trading companies in the future.
The five major trading companies in Berkshire Hathaway's portfolio are: Mitsubishi Corporation (8058.JP), Mitsui & Co., Ltd. (8031.JP), Itochu Corporation (8001.JP), Sumitomo Corporation (8053.JP), and Marubeni Corporation (8002.JP).
They are all component stocks in the Nikkei 225 Index and belong to the trading companies under the materials sector. Japanese trading companies are relatively unique enterprises, with a focus on trade in the past, but now with a greater emphasis on investment. The five companies in Berkshire Hathaway's portfolio are the oldest and largest in Japan, with investments covering multiple industries.
Potential reasons for Buffett's long-term investment in Japanese stocks:
Undervaluation: Buffett expressed this when he first bought in 2020.
Better corporate governance: After Abenomics, Japan introduced better listing company governance guidelines, placing greater emphasis on capital efficiency, improved return on equity (ROE), and increased shareholder returns.
Depreciation of the yen: Buffett's strategy is to buy Japanese stocks using the yen. According to analysis by CICC, the current depreciation of the yen has led to a 'breakdown' in the relationship between the USD/JPY exchange rate and purchasing power parity, which may lead to a future appreciation of the yen or an increase in inflation.
How to invest in the Nikkei 225 Index
How can investors invest in the Nikkei 225 Index?
As the index itself cannot be invested directly, but can be invested in the Nikkei 225 index through active funds, ETFs, index futures, and other ways. Investing in the large-cap index ETF should be one of the most common methods.
1. Japan Market
In the domestic Japanese market, there are multiple ETFs directly tracking the movements of the Nikkei 225 index. According to data from the Japan Exchange Group, there are a total of 10 ETFs tracking the Nikkei 225 in the Japanese stock market. These ETFs are also denominated in yen and their price fluctuations almost coincide with the movements of the Nikkei 225 index.
But these ETFs can only be traded on the Japanese stock market. So how can overseas investors invest in the Nikkei 225 index? In fact, there are also ETFs tracking the Japanese stock market in the Hong Kong and US stock markets.
Data source: The screening criteria for related ETFs from Japan Exchange Group are all ETFs tracking the Nikkei 225 index as listed on Japan Exchange Group.
2. Hong Kong Market
In the Hong Kong market, there are a total of three ETFs tracking the movements of the Japanese stocks, of which only the Southbound Nikkei 225 (3153.HK) tracks the Nikkei 225 index, while the other two track the MSCI Japan Index and FactSet Japan Global Leader Index, respectively.
It's worth noting that exchange rates are one of the important factors that overseas investors need to consider. When holding overseas assets, forex fluctuations can result in unrealized gains or losses when converting back to the base currency after closing positions. In other words, if your base currency is Hong Kong dollars or US dollars, if the Japanese yen depreciates against the US dollar, it may offset the gains from the index's rise, or even cause losses.
Therefore, in addition to regular index ETFs, there are also forex-hedged versions of index ETFs. The principle of forex hedging is that index funds not only track index holdings, but also hold financial derivatives such as forex forward contracts to hedge forex risks. Currently, most representative products are designed from the perspective of investors holding US dollars.
Simply put, the fluctuation of the exchange rate hedged version of the Japanese stock ETF may be closer to the trend of the tracked Japanese stock index.
Data Source: Futubull. The screening criteria for related ETFs are all related Japanese stock ETFs listed in Hong Kong, as of February 27, 2024, the top three in total assets. The year-to-date fluctuation is calculated from the first trading day of 2024 to February 27, 2024. Southern Dongying Nikkei 225 Index ETF was issued on January 31, 2024, and its fluctuation is calculated from January 31, 2024 to February 22, 2024.
3. US Stock Market
In the US stock market, there are hardly any large-scale Japanese stock ETFs directly tracking the Nikkei 225 Index.
This may be because the Nikkei 225 Index is price-weighted, which does not conform to the current mainstream market-cap weighted approach. They are more likely to track indices such as the MSCI Japan Index or some forex-hedged indices.
Like Hong Kong, Japanese stock ETFs traded on the US stock market are also divided into regular ETFs and forex-hedged ETFs. The largest in terms of scale, EWJ, and the fifth largest in terms of scale, DBJP, both track the MSCI Japan Index. However, the increase of EWJ is much lower than that of DBJP, which may be mainly due to the impact of the depreciation of the Japanese yen on EWJ, offsetting the increase, while DBJP has forex hedging, making it closer to the trend of the Nikkei 225 Index.
Data Source: ETF Database. The screening criteria for related ETFs are all related Japanese stock ETFs listed on the US stock market, as of February 24, 2024, the top five in total assets. The year-to-date fluctuation is calculated from the first trading day of 2024 to February 24, 2024.
It is worth noting that there are risks in investing in Nikkei ETFs:
Most of these ETFs track the major market indices, so if the index falls, the related ETFs will also decline, causing losses to investors. Since many Japanese companies have a high proportion of overseas income, if the global economy enters a recession, the Nikkei may also be affected.
In addition, index ETFs sometimes cannot fully replicate the performance of the index. Factors such as management fees, transaction costs, tracking error, and liquidity may affect the returns of index ETFs.
Finally, whether investing in local Nikkei ETFs in the Japanese market or Nikkei ETFs in the Hong Kong and US markets, there will be exchange rate risks. Due to the depreciation of the yen over the past year, it may offset the gains from the index's rise. For example, EWJ, which does not consider the impact of the yen's depreciation, has a much smaller increase compared to DXJ, which hedges against currency risks.
Therefore, investors need to make investment decisions and take risk management measures based on their own investment objectives and risk tolerance.
Key points to summarize:
The Nikkei 225 Index is one of the most representative stock indices in the Japanese stock market, tracking the 225 most liquid stocks listed on the Tokyo Stock Exchange.
The stock selection rules of the Nikkei 225 Index are based on liquidity, selecting stocks with the most active trading volume and the highest market liquidity. The index is adjusted every six months, replacing constituent stocks regularly and assigning weights based on price.
The components of the Nikkei 225 index are mainly concentrated in the technology and consumer sectors, with the top ten largest holdings including Fast Retailing, Tokyo Electron, Advantest, and SoftBank Group.
The Nikkei 225 index has witnessed multiple economic changes in Japan, including rapid growth, bubble burst, etc. In recent years, through government reform measures, the Nikkei index has rebounded, reaching a new historical high for the first time in 34 years.
Investors can indirectly invest in the Nikkei 225 index through various means such as actively managed funds, ETFs, and index futures. Among them, large-cap index ETFs are one of the most common methods, with ETFs tracking the Nikkei 225 index available in the Japanese market and the Hong Kong and US stock markets. At the same time, currency-hedged versions of index ETFs can reduce forex risks. However, investing in Japanese stock ETFs also carries risks, including market downturns, management fees, liquidity issues, and exchange rate fluctuations that need to be considered.
