$23 Billion Massive Withdrawal! The Japanese Are Handing Over the Bull Market to Foreigners

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Japan’s financial markets are experiencing a long-awaited wave of reflation trades, but domestic investors are unexpectedly absent from the feast.

According to statistical data, foreign capital inflows this year have reached their strongest levels in the past decade, likely to hit a record high since the capital inflows triggered by Abenomics in 2013. Foreign investors have led this round of rally that pushed the Tokyo stock market to record highs, while heavily selling Japanese government bonds, sending the 30-year government bond yield to a historical peak.

According to Nicholas Smith, a strategist at CLSA Securities in Tokyo, “Global investors have always been the main driver behind the rise in Japanese stocks,” and as the TOPIX index bounced 34.2% from its April lows, “there is almost no sign that domestic investors are chasing the rally.”

Meanwhile, retail investors in Japan have withdrawn about $23 billion this year, reflecting a cautious attitude towards the market outlook. Analysts believe that if Japanese retail investors return, the stock market rally may have further upside potential.

Factors such as changes in Bank of Japan policy have triggered asset rotation effects, but the absence of fund inflows has become a key limiting factor. Despite sharp swings in the equity and bond markets, the yen exchange rate has been relatively stable, fluctuating between 140 and 160 over the past two years, and has not benefited from the stronger growth outlook or capital inflows.

Market Structure Shift Under Foreign Dominance

Foreign investors are reshaping the structure of Japan’s capital markets.

Against the backdrop of government-supportive policies and corporate reforms reigniting economic growth after nearly three decades of stagnation, the Bank of Japan this year raised interest rates for the first time and reduced its massive bond holdings—the first rate hike action since before the 2008 global financial crisis.

This policy shift triggered an asset rotation from bonds to stocks, boosting battered industrial stocks at the expense of more attractive growth stocks, while favoring short-term bonds over long-term bonds.

The trend of value stocks outperforming growth stocks reflects a typical feature of reflation trades, which quantitative investors often interpret as a sign of more dispersed economic growth throughout the economy.

CLSA’s Smith pointed out, "Foreigners are not the only buyers: corporate stock repurchases have been even larger. This is very exciting because companies are cash rich and able to buy more shares."

Strong Wait-and-See Sentiment Among Domestic Investors

The absence of Japanese retail investors has become a notable feature of this rally. Bernstein analysts attributed retail investors’ caution in a research report to uncertainty over how US tariffs might affect the Japanese economy, along with market volatility.

However, things may be changing. Bernstein analysts said, "After hitting extremely pessimistic levels, retail investor sentiment has finally turned positive again since last week."

They believe that the combination of earnings recovery, strong foreign investor confidence, and the return of retail money "appears to be quite favorable for the market."

Analysts believe that if Japanese retail investors return to the market, the stock market rally could continue further. The current reflation trade is still mainly driven by foreign capital; the degree of domestic investor participation will determine how sustainable this rally is.

Funding Dilemma Behind the Stable Yen Exchange Rate

Even as the stock and bond markets have seen major shifts, the yen has been relatively stable, drawing market attention. Brad Setser of the Council on Foreign Relations pointed out that "The biggest issue is the lack of funds returning."

He attributed this to Japanese institutions’ heavy investment in the US Treasuries market before the pandemic, and after the Fed rate hikes, these investments are actually in a loss position. In short, Japanese capital chose to stay overseas rather than returning home to chase yields.

This configuration creates unique arbitrage opportunities. Foreign buyers are able to obtain a considerable yield spread between Japanese government bonds and US Treasuries of the same duration. The five-year US Treasury yield is only 3.86%, while the same term Japanese government bond yield, once converted to US dollars, reaches 5%. This bond market arbitrage opportunity can only be achieved when there is a large interest rate differential between the Fed and the Bank of Japan.

But this advantage exists only in one direction. Due to the relatively low interest rates of the Bank of Japan, Japanese investors find it more costly to invest in the US market on a currency-hedged basis, which further explains why domestic funds have not returned on a large scale.

Markets are closely watching whether Japan's asset rotation will continue to deepen. Although Japan has lost its status as the world’s largest creditor nation this year, it still holds a large amount of financial assets overseas, and in theory, these assets could be sold and repatriated.

Risk Warning and DisclaimerThe market has risks, and investment needs caution. This article does not constitute personal investment advice, nor does it take into account the special investment objectives, financial status, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular situation. Investments made on this basis are at your own risk. ```