Japan's Current Account Surplus: A Structural Anchor for the Yen and Equity Opportunities

Japan's current account surplus has reached historic heights, driven by a record-breaking primary income component fueled by a weak yen and expanding overseas investments. While debates persist about the sustainability of yen strength amid structural reinvestment trends, the data reveals compelling opportunities for investors in Japanese equities and bonds. Let's dissect the drivers, challenges, and actionable strategies.

The Surplus Engine: Primary Income and the Weak Yen

Japan's current account surplus hit ¥30.4 trillion in fiscal 2024, the highest since records began in 1985. The primary income surplus—comprising returns from overseas investments—accounted for the bulk of this gain, surging 11.7% year-on-year to ¥41.7 trillion. This is largely due to the yen's depreciation, which amplifies the yen-denominated value of dividends and interest from Japanese firms' foreign subsidiaries. For instance, a weak yen converts higher foreign-currency earnings into more yen, boosting reported profits.

However, a critical nuance emerges: a significant portion of these earnings—34% of direct investment income in Asia—is reinvested abroad rather than repatriated. Mizuho Bank's “cash flow-based” analysis shows that excluding reinvested earnings reduces the surplus to just ¥3.6 trillion in Q2 2024, versus the reported ¥6.7 trillion. This suggests that the surplus's immediate yen-supporting impact is diluted, but the structural dominance of primary income remains intact.

Why the Yen Might Still Hold Up

Bearish yen forecasts often cite low hedging ratios (below 50% for insurers) and capital outflows. Yet, three factors argue for resilience:
1. Foreign Investment Returns: Even reinvested earnings contribute to Japan's external asset pool, which totaled ¥327 trillion in direct holdings by Q1 2024. These assets generate ongoing income, providing a long-term floor for the yen.
2. Trade Deficit Narrowing: While Japan's goods trade deficit persists, services—particularly tourism—are now a net positive. Travel surpluses hit a record ¥6.7 trillion in fiscal 2024, offsetting digital service deficits.
3. Global Demand for Yen-Denominated Assets: Despite low yields, Japanese government bonds (JGBs) remain a haven for global investors in volatile markets.

Investment Opportunities: Where to Play the Surplus

Equities: Target Overseas-Exposed Sectors

1. Manufacturing and Automotive: Companies like Toyota and Honda, with large Asian manufacturing footprints, benefit from reinvested earnings boosting local production. Their foreign subsidiaries' profits, when converted back to yen, provide a natural hedge against currency volatility.
2. Technology and Semiconductors: Firms like Sony and Toshiba, which derive significant revenue from global tech demand, are poised to capitalize on rising export volumes.
3. Financials: Banks and insurers with substantial foreign portfolios (e.g., Mitsubishi UFJ Financial Group) gain from higher returns on overseas assets.

Bonds: Focus on Corporate and Infrastructure Debt

• Corporate Bonds: Issuers with strong foreign cash flows (e.g., Toyota) offer higher yields than JGBs, with currency risk mitigated by their yen-earning activities.
• Infrastructure Bonds: Projects linked to Japan's overseas investments in Asia (e.g., railways or energy) could benefit from reinvestment-driven growth.

Risks and Mitigation

• Yen Overshooting: If the yen strengthens sharply, exporters' margins could compress. Use currency forwards to hedge exposure.
• Global Recession: A slowdown in Asian economies might reduce reinvestment returns. Diversify into domestic sectors like healthcare or consumer staples.

Recommendations

1. Overweight Japanese Equities: Allocate to a basket of overseas-exposed manufacturers, tech firms, and financials.
2. Underweight JGBs: Prioritize corporate bonds for yield, but keep a small JGB allocation for portfolio stability.
3. Currency Strategy: Pair equity exposure with a 20% allocation to USD/JPY put options to protect against yen weakness.

Conclusion

Japan's current account surplus, despite reinvestment headwinds, remains a structural pillar supporting the yen and equity valuations. Investors who focus on companies benefiting from global operations and reinvested earnings can capitalize on this trend. While risks exist, the surplus's longevity—driven by decades of overseas asset accumulation—positions Japan as a compelling market for strategic allocation.

The verdict? Look east—but look selectively, and with hedged optimism.