Japanese stocks are enjoying a banner year. But while foreign investors are piling into the market, local investors have not been as enthusiastic. Data from Japan Exchange Group shows domestic investors have sold around 53 billion yen, or around $340 million, in companies belonging to the TSE Prime index between February and mid-May. Foreign investors, meanwhile, have bought 270 billion yen, or $1.7 billion, in shares during that time. Foreign-domiciled Japanese stock funds also grew by $7.5 billion in assets between January and mid-April versus the $4.1 billion flowing into their domestic counterparts, according to EPFR data. The latest wave of selling comes as the Nikkei 225 has pulled back from the record levels reached in March. Quarter to date, the benchmark is down 4.3%, though it remains 15% higher for 2024. It also comes as the country’s economy slows and as rates remain low relative to the U.S. — putting pressure on the yen against the dollar. .N225 YTD mountain Nikkei in 2024 Geopolitical tensions across the Middle East and a weakening of semiconductor stocks, which powered the Nikkei’s rally, contributed to the Japanese stock market taking a breather in recent weeks. Persistent inflation in the U.S. has also pressured Japanese equities, Goldman Sachs noted. “The broader disinflationary narrative remains intact, but risk sentiment is unlikely to quickly recover until the market becomes more confident that disinflation has only been delayed, and that inflation is not re-accelerating,” the bank wrote in late April. “While risk-reward uncertainty became higher than previously assumed, we maintain our constructive stance on Japanese equities.” Japanese investors are hesitant Japanese investors have long been skeptical of the local stock market after the asset price bubble burst in the early 1990s. More than half of the country’s household assets are in deposits, compared with 14% in the U.S., according to Morgan Stanley. Local investors have also historically preferred U.S. and other foreign equities to Japanese ones. Another reason Japanese investors may not be as keen on their domestic market could be the yen falling sharply. The Bank of Japan took steps in 2024 toward monetary policy normalization after years of negative interest rates, including a March hike to a zero-to-0.1% range, up from -0.1%. However, this stands in stark contrast to the Federal Reserve’s rate policy in the U.S., which is still ranging between 5.25% and 5.5%. This rate differential has sparked a sell-off in the Japanese yen , which is trading near its lowest levels in more than three decades against the U.S. dollar. Though a weaker yen benefits some corners of the Japanese markets — it aids large exporters who sell products into a stronger U.S. dollar — it can be a double-edged sword as it weakens the purchasing power of individuals and companies dealing in the local currency. This is also enough to make older investors more willing to cash in on their profits. As of 2023, almost a third of the population was 65 or older, according to population numbers from the Ministry of Internal Affairs and Communications . Older investors tend to be more risk-averse. Many older investors in the country are also less keen on the country’s stock market after seeing it struggle for more than three decades and living through a stagflationary economic period. Younger generations without the trauma of the equity bubble are warming to the trend, however. Nearly a quarter of people in their 20s invested in mutual funds in 2023, almost four times the rate from 2016, according to research from the Investment Trusts Association. Prime Minister Kishida Fumio’s government also revamped the terms of the Nippon Individual Savings Account, or NISA, the country’s tax-free stock investment program, to spur a shift to investing versus cash. However, “younger generations … may not have quite the same amount of capital the older generations do, so it may still not be enough to move the needle,” said Julian McManus, portfolio manager at Janus Henderson. There are also concerns that more flows from the NISA reform may also reach U.S. and other overseas markets versus the domestic market. Nearly 60% of flows in 2023 from Japanese domestic equity funds went toward U.S. and Indian stocks, Bernstein noted. Outlook for Japanese stocks still strong Despite the recent bout of selling from local investors and the market’s recent struggles, many global investors remain bullish on Japanese stocks. One factor boosting the outlook for these names is corporate governance reforms enacted by the government. This is another “slow-moving but important tailwind to Japanese stocks,” with more room to run, according to Zachary Hill, Horizon Investments head of portfolio management. A potential rebound in the yen as the Federal Reserve begins lowering rates would also bolster Japanese equities. Overall, the lagging domestic participation in the market rally “does not have a major bearing on our outlook for Japan,” said Raymond Chan, Asia Pacific chief investment officer at Allianz Global Investors. “We are still optimistic on the outlook,” said Chan. “We see an improving picture for corporate earnings together with valuations which, in our view, do not discount the fundamental change being brought about by the governance reforms and enhancement of shareholder value.” McManus noted that, while it was unusual for equities to fall alongside a weaker yen, he’s still optimistic on opportunities in the Japanese market. “To the extent that the currently weak yen persists, it continues to reinforce, but is not really the crux of our investment cases on most of our Japanese holdings.” Another vote of confidence in the Japanese market comes from Warren Buffett. Last year, he raised his stakes in five of the country’s trading houses — Mitsubishi , Mitsui , Itochu , Marubeni and Sumitomo .