As 2024 reaches its conclusion, the Japanese stock market has exhibited stability in its performanceHowever, the ongoing withdrawal of foreign capital adds layers of uncertainty to its futureThe data from the Japan Exchange Group shows that by the third week of December, overseas investors recorded a staggering net sell-off amounting to 275.5 billion yen in the spot market aloneWhen looking into the futures market, which is characterized by more pronounced short-term investment behaviors, the cumulative net sales for the year hit a staggering 4.8503 trillion yenCombining both spot and futures markets, the total net sell figure exceeds 5 trillion yenThis starkly contrasts with the approximately 6 trillion yen net purchases witnessed throughout 2023.

In comparison to the ever-rising heights of the American stock market, Japanese markets are grappling with heightened volatility, dismal policy expectations, and fluctuations in exchange rates that are perceived to be undermining their appeal to overseas investors

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Nonetheless, some strategists hold a cautiously optimistic view of the Japanese marketThey assert that recent corporate governance reforms have played a crucial role in bolstering the confidence of foreign investors.

Rie Nishihara, a strategist from JPMorgan, shared her insights with reporters, stating, "As the economy progressively transitions toward normalcy in its third year, we anticipate the Japanese stock market entering a phase of sustained growth, fueled by deep structural changes in corporate behavior catalyzed by governance reforms." She went on to highlight macroeconomic effects stemming from policies, such as a relatively weaker yen, which could bring forth new growth dynamics for the Japanese market.

The tremors following the August crash

From the beginning of the year until mid-May, overseas funds had aggressively net bought Japanese stocks, nearing 5 trillion yen

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However, this trend swiftly reversed, turning into a net sell-off after JuneThe interest of foreign capital in the Japanese stock market has seen a comprehensive decline, stemming from macro funds that base their strategies on monetary policy and economic outlook to those employing short-term volatility chasing, known as CTA strategies.

A pivotal reason behind the retreat of foreign capital is the persistent high volatility within the Japanese marketThe Nikkei index faced a dramatic drop of over 4400 points in a single day in August, marking a significant turning point for foreign investors withdrawing from the marketThe Nikkei Stock Average Volatility Index, which reflects volatility expectations, skyrocketed above 80 in August, and although it has since retraced, it still hovers above 20. This metric has become a crucial determinant of investor confidenceThe dip in the market was driven by various factors, including rising expectations for the Bank of Japan to implement interest rate hikes, uncertainties surrounding the U.S

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economic outlook, and shifts in global capital flows.

Another deterrent for investors is the uncertainty surrounding exchange ratesProspects surrounding the Bank of Japan’s interest rate trajectory and the future of the U.Seconomy are shrouded in ambiguity, adding a layer of complexity to market forecastsPatrick Brenner, global head of diversified asset investment at Schroders, remarked, “The Japanese stock market has become significantly sensitive to changes in exchange rates and interest rates, making it challenging for long-term investors to absorb the risks posed by substantial fluctuations in asset values due to currency movements.”

The "internal rise and external decline"

A lack of attractive policies has also constituted a significant factor behind the withdrawal of foreign investmentsUnlike the potential incentives of tax reductions that a future U.S

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government could offer to attract capital, the Kishida administration seems to be more focused on internal adjustmentsThese include enhancing fiscal stability and advancing social security reforms, but without significant breakthroughs in easing market entry or stimulating foreign investmentMasatoshi Kikuchi, chief equity strategist at Mizuho Securities, commented, "The Kishida administration’s policies are primarily concentrating on internal adjustments, lacking measures to attract overseas capital, which has led to its low standing among international investors."

Nevertheless, the Japanese stock market still registered a remarkable 18% annual increase in 2024, primarily supported by large-scale stock buybacks by listed companiesFrom the start of the year to December, so-called “corporate entities” net bought a staggering 7.8 trillion yen, almost fully absorbing the selling pressure from overseas investors.

However, this reliance on corporate buybacks has raised long-term concerns regarding the market