UBS Global Wealth Management expects Japan’s cheaply valued stocks to extend their outperformance into 2024 amid a revival in domestic economic growth and gradual monetary policy tightening.

Value stocks will rally as the economy may post 3% to 4% nominal growth next year and the Tokyo Stock Exchange pushes for better returns on equity, Min Lan Tan, who leads the Asia Pacific chief investment office at one of the world’s largest wealth managers, said in an interview. “The underlying story for Japan is still that it is in the midst of a positive inflation loop.”

Heavyweight lenders in particular stand to benefit from a measured lifting of interest rates by the Bank of Japan, potentially starting in the first quarter of next year, she added. UBS expects monetary policy to remain accommodative and favorable to risk assets.

A gauge of so-called value stocks, a cohort that looks relatively cheap compared with fundamentals, has rallied 30% this year as Asia’s second-largest economy came out of the doldrums after three decades. The outperformance of the MSCI Japan Value Index against a broader gauge has, however, hit a roadblock in the current quarter as investors locked in gains amid concerns about the economic outlook.

“This year is crazy” considering that nominal economic growth is about 5% compared with 30 years of being below 0.5%, Tan said. As inflation persists, the central bank might even do away with its cap on long-term bond yields, she added.

Despite the optimism on value shares, UBS’s wealth arm has a neutral allocation to the broader Japanese market, while its most preferred countries in Asia are China and India. The Singapore-based executive in mid-July said she was awaiting a 5% to 8% correction in Japanese stocks before adding to positions. The MSCI gauge subsequently fell as much as 3.1% before climbing back up to a near 33-year high.

The MSCI Japan Value Index is currently trading near book value, whereas the broader gauge is at a multiple of 1.4 times.

UBS is among the many foreign money managers lauding Japan for making a strong push to improve returns and valuations, with the Tokyo bourse set to release names of companies that are outlining capital improvement plans from 2024.

“When return on equity shows sustainable improvement,” value stocks re-rate, Tan said.

--With assistance from Winnie Hsu.