As 2024 draws to a close, Japan's stock market exhibits a generally strong performance, yet the ongoing withdrawal of foreign investments introduces significant uncertainties regarding future prospectsRecent data from the Tokyo Stock Exchange Group underscores this trend, illustrating that foreign investors recorded a staggering net selling amount of 275.5 billion yen in the spot market by the third week of DecemberNotably, in the realm of index futures, characterized by a more speculative investment approach, the cumulative net selling throughout the year reached an eye-watering 4.85 trillion yenWhen combined, the net selling across both spot and futures exceeds an alarming 5 trillion yen, starkly contrasting with the approximately 6 trillion yen in net purchases realized over the entirety of 2023.

In contrast to the relentlessly climbing heights of American stock markets, Japan’s market displays a persistent high volatility, compounded by a gloomy outlook on policy expectations and unpredictable currency trends

This scenario has contributed to a diminished allure for foreign investorsHowever, some strategists maintain a cautiously optimistic stance toward the Japanese market, asserting that recent corporate governance reforms have significantly bolstered foreign investor confidenceThis perspective suggests a potential shift in the paradigm of investment attractiveness.

Strategist Miki Nishihara from JPMorgan highlights, “As we enter what we expect to be the third year of an economic transition toward normalization, we foresee the Japanese stock market entering a sustained growth phase, propelled by structural changes in corporate behavior spurred by governance reforms.” She also notes that certain macroeconomic effects triggered by U.Spolicy—such as the relative depreciation of the yen—could serve as new stimulants for growth within Japan’s market.

Aftershock of August's Plunge

In the period from the start of the year until mid-May, foreign funds displayed a significant net purchase of Japanese stocks in the spot market, amounting to nearly 5 trillion yen

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This trend, however, drastically reversed as the second half of the year progressed, yielding a net selling phaseThe psychologists behind macro funds, rooted in monetary policies and economic outlooks, alongside the short-term volatility-seeking CTA strategies, indicate a waning interest from foreign investors in Japan’s stock market.

A critical catalyst for the exodus of foreign capital is the persistently high volatility within Japan's marketThe Nikkei Average experienced a staggering drop of over 4,400 points in a single day in August 2024, marking a definitive turning point that catalyzed a surge in foreign capital outflowsThe Nikkei VI Index, which reflects volatility expectations, skyrocketed past the 80 mark in August—a concerning sign for investorsWhile it has since receded, it continues to hover above 20, influencing investor sentiment significantlyThis sharp decline was precipitated by multiple factors, including rising expectations of an interest rate hike by the Bank of Japan, uncertainties surrounding the U.S

economic outlook, and broader shifts in global capital flows.

Currency volatility emerges as another deterrent for investorsThe pathways of Japan's monetary policy juxtaposed with uncertainties in the U.Seconomy introduce an additional layer of difficulty in forecasting market trendsPatrick Brenner, a global head of diversified asset investments at Schroders, remarks, “The Japanese stock market has become significantly more sensitive to fluctuations in both exchange rates and interest rates, making it exceedingly challenging for long-term investors to bear the risks associated with substantial currency volatility.”

Internal Focus with External Decline

The conspicuous lack of attractive policy initiatives is yet another major factor driving foreign capital outflowsIn stark contrast to anticipated capital-attracting measures, such as tax reductions from a potential new U.S

administration, the current government led by Shioyuki Ishiba emphasizes internal adjustments—focusing on enhancing fiscal stability and advancing social security reformsHowever, there have been no noteworthy breakthroughs aimed at relaxing market access or stimulating foreign investmentMasatoshi Kikuchi, chief equity strategist at Mizuho Securities, asserts, “The Ishiba administration's strategies are heavily centered on internal adjustments, lacking impactful initiatives to attract offshore capital, which results in limited positive appraisal among international investors.”

Notwithstanding these challenges, the Japanese stock market still managed to achieve an 18% gain over the year, primarily sustained by large-scale stock buybacks from listed companiesFrom the beginning of the year through December, the so-called “corporate entities” net purchasing figure reached 7.8 trillion yen, almost entirely absorbing the selling pressures from foreign investors.

Nevertheless, there is growing concern regarding the sustainability of this reliance on corporate repurchases in the long term