Composed of the 225 largest companies listed in the first section of the Tokyo Stock Exchange, the Nikkei 225 index holds significant importance for investors and traders as one of Japan's key market indices. It serves as a benchmark providing insights into the performance of the Japanese economy as a whole.
But now that the index is breaking records that have been standing since the 90s, is it time to bet on the Japanese economy? Let’s first remind our readers what the Nikkei index is, and what influences its value.
What is the Nikkei 225?
The Nikkei 225 is a prominent stock index of the Tokyo Stock Exchange, which ranks among the world's largest exchanges based on market capitalization and trading volume.
Understanding the composition of an index is crucial for investors as it enables them to assess associated risks and make informed decisions. Additionally, it allows investors to align their investment strategy with their sector preferences or market outlook.
As of the time of writing, the technology sector dominated the Nikkei Stock Average, representing 48.85% of the Japanese index with 60 companies. The consumer goods sector accounted for 23.41% with 34 companies, followed by the materials sector at 12.61% with 53 companies. The capital goods/other sector comprised 10.37% of the index with 36 companies.
Curious as to which companies form the top 5 components of the Nikkei 225 index by weighting? Here are the rankings as of the 5th of June 2023:
- Fast Retailing Ltd (consumer goods) = 10.76%.
- Tokyo Electron Ltd (technology) = 6.36%.
- Advantest Corp (technology) = 3.93%.
- SoftBank Group Corp (technology) = 3.60%.
- Daikin Industries Ltd (capital goods/others) = 2.91%.
- Kddi Corp (technology) = 2.82%.
Investing in an index provides diversification across multiple sectors, which generally reduces the risk of overexposure to a single sector. However, it's important to note that some indices have a higher concentration in specific sectors. For example, the Nasdaq and the Nikkei 225 are primarily focused on technology, while the DAX 40 is oriented towards industrials and chemicals, among other sectors.
What influences the value of the Japanese index?
In some cases, the value of the index can go up, but it is also possible that the index loses value. Some regulated brokers like ActivTrades offer financial derivatives, such as CFD or Contracts For Difference, that allow you to trade bearish markets in addition to bullish ones.
Regardless of the market conditions you want to take advantage of, if you want to trade the Nikkei 225, it is essential to know more about what can influence its value:
- The health of the Japanese economy and its growth prospects.
- The monetary policy adopted by the Bank of Japan (BoJ).
- The value of the Japanese yen.
- The local and global economic, political and geopolitical situation.
- The performance of other global indexes and market psychology.
Should you still trade the Nikkei 225 index given that it has reached its highest level in 33 years?
In 2023, the Japanese stock market regained attention and interest from investors all over the world, after having been overlooked for quite some time. Notable investors such as Warren Buffett, as well as smaller investors seeking portfolio diversification, are now showing renewed interest in the Japanese market, supporting the currency progression of the most popular index.
Since the beginning of the year, the Japanese stock market has been performing pretty well and better than some other major indices around the world, as it has risen by almost 25% since January. Currently, it is at its highest level in over 33 years, at around 32,217 points. This increase is driven by growing investor confidence and a greater risk appetite from market participants.
Monthly Chart of the Nikkei 225 - Source: TradingView
Several factors have contributed to this positive trend recently. In the United States, a debt ceiling agreement has been reached, preventing a disastrous default. Additionally, the latest job figures in the US published on Friday were strong, although the unemployment rate rose, indicating a potential slowdown in hiring. Wage growth also slowed down in May, which may indicate that the Federal Reserve could avoid raising interest rates further in June.
Furthermore, investors are anticipating that the Bank of Japan will maintain the current status quo and accommodative monetary policy during its upcoming meeting, adding to the overall positive sentiment.
If you want to consider the bigger picture, it seems that Japanese stocks have been cheaper options than American stocks over the last few years, and that Japan could profit from the tensions between the US and China.
When it comes down to the different sub-sector breakdown between the 2 indices and their relative growth prospect, it seems that Japanese stocks have been trading at lower price-to-sales and price-to-book rations than American stocks, while offering higher earnings yields and dividend yields as described by the CME Group.
The same situation applies if you take into account the CAPE ratio or Shiller PE ratio as shown by Barclays.
It is also important to take into account the recent significant depreciation of the Japanese yen (JPY) against the American Dollar (USD), as the JPY/USD lost almost 32% between January 2021 and October 2022, going from 0.009677 to 0.006583. Even though the JPY has been gaining positive momentum since October (around +7.5% between its trough and today), the previous fall improved the international competitiveness of Japanese products on foreign markets.
Monthly Chart of the JPY/USD - Source: TradingView
While some believe that the bull run might be solid, others are doubtful about the capacity of Japan to show any fundamental turning point supporting the idea of a new growth dynamic, as the Bank of Japan is still implementing an ultra-loose monetary policy and the population of Japan is both declining and getting older, supporting higher savings rather than spending.
Interested in trading the Nikkei 225? The morning session runs from 9:00 a.m. to 11:30 a.m. JST, while the afternoon trading session runs from 12:30 pm JST and ends at 3:00 PM JST. Don’t forget to take into consideration days off for the Japanese stock market.
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