U.S. stocks may be charging higher since the presidential election, but some analysts see more opportunity in the Japanese markets.
"Japan is now our top pick in global equity regions, replacing the U.S.," Jonathan Garner, Morgan Stanley's chief Asia and emerging market equity strategist, said in a note Sunday.
The firm issued a "double upgrade" on Japanese stocks, moving its rating two rungs higher to overweight and reversing a previously negative view on the country. Japan's economy has struggled to post substantial growth since at least the late 1980s.
The positive turn on Japanese stocks comes with the yen's new weakness against the U.S. dollar, which has surged to its highest level in more than 13 years. The yen is down almost 8 percent against the dollar for November, hitting 113.89 last week, its lowest level versus the greenback since March.
"There comes a point where the weak yen and the (Japanese government 10-year bond yield) pegged to zero that starts to make Japanese equities look attractive," Lee Ferridge, head of macro strategy, North America, at State Street Global Markets, said last week. If he were to look at any country's stocks outside the United States, he said, "it would be the Nikkei."
The is up about 3 percent since the U.S. election on Nov. 8, while Japan's Topix index is the best performer globally with gains of about 6 percent, in local currency terms.
BlackRock has been recommending Japanese stocks this year given already favorable conditions of stimulus from both government spending and central bank policy, as well as improved corporate governance, said Russ Koesterich, head of asset allocation for BlackRock's Global Allocation Fund.
"Japan is still far and away the cheapest of the developed markets," he said. The yen's weakness "has created a further catalyst."
Some of the stocks Morgan Stanley identified as benefiting from a weakening yen include semiconductor manufacturer Sumco, automakers such as Toyota Motor, Honda Motor and Mitsubishi Motors, and electronics components manufacturer TDK.
U.S. President-elect Donald Trump's surprise victory this month has prompted investors to shift the types of stocks and other investments they hold. The major U.S. indexes have rallied to all-time highs as financials extended gains and beaten-down sectors such as industrials climbed.
Emerging markets vs. Japan net equity fund flows ($ billions)
In contrast, the iShares MSCI Emerging Markets ETF (EEM) has fallen more than 5 percent since the election. The post-election surge in the dollar has pressured emerging market countries, whose dollar-denominated debt holdings become more costly to pay back when their currencies weaken.
Emerging markets funds saw their fourth straight week of outflows last week, Citi said in a Thursday note. Meanwhile, according to Garner's analysis, Japanese stock funds started to see inflows after the U.S. election.
"In an environment where the dollar's appreciating, that's going to be an environment that's more favorable for developed markets and headwinds for emerging markets, both on the stocks and bonds side," BlackRock's Koesterich said.
However, "I think there are pockets of EM where it has gone too far," he said, noting opportunities in individual Chinese stocks, especially some traded in Hong Kong.
In the same Sunday note, Morgan Stanley turned positive on offshore Chinese stocks tracked by MSCI China, while downgrading emerging markets overall to a negative view.