The appreciation of the yen has become an “invisible killer” for the Japanese stock market: although export companies’ profits exceed expectations, their stock prices remain weak and the foreign exchange dividend is receding.

According to Zhiyong Finance APP, the risk that Japan may take further measures to support the yen has clouded corporate earnings outlooks, as investors are weighing the impact of any yen appreciation on exporters' profits. Over the past two years, a weak yen has been the main driver behind Japan's exporters exceeding profit expectations, especially as many companies had previously set more optimistic currency forecasts. For example, Honda Motor (TM.US) announced last week that foreign exchange contributed 91 billion yen to its first-quarter operating profit, allowing its results to surpass market expectations.

Frank Benzimra, Head of Asian Equity Strategy at Societe Generale, said: “Market sentiment is cautious at present. The yen is undoubtedly a risk factor for the stock market that needs attention.”

Benzimra noted that as the impact of recent joint intervention by Japan and the US fades, equity investors worry that the Bank of Japan may accelerate rate hikes. He also added that any further currency volatility would put pressure on the stock market, especially on shares of automakers.

This quarter’s performance mostly exceeded analysts' expectations, but not all positive results translated into share price gains; some companies even saw their stock prices fall after reports. According to data, in the April-June quarter last year, companies with net profits above expectations outperformed the MSCI Japan Index by an average of 1% on the day after results. This year, companies that beat expectations have underperformed the index by 0.5%.

As the yen’s trajectory becomes increasingly unpredictable, investors are beginning to doubt companies that rely on weak currency to boost profits. Shares of several well-known exporters with strong earnings this quarter subsequently declined, including camera maker Canon and pharmaceutical company Takeda Pharmaceutical Company Limited.

Industry research strategists Laurent Douillet and Aditya Khanduja wrote in a report: “The market response is cautious; the factors driving earnings beats are currency fluctuations, not operational improvements.”

They cautioned that, given the authorities' demonstrated “official determination” to stabilize the yen, future upward earnings revisions will require stronger operating performance rather than favorable currency movements.

Chris Smith, portfolio manager at Polar Capital, stated that investors’ increasingly selective approach reflects more of a shift in strategy, rather than broader headwinds facing the Japanese market.

He said that as uncertainties increase—such as those tied to the yen, geopolitics, and the artificial intelligence capital expenditure cycle—more traders are adopting a bottom-up investment strategy rather than buying baskets of exporter stocks. He predicts that manufacturers with robust demand channels, such as chip equipment makers, should remain resilient even if the yen strengthens.

Benzimra said that any significant appreciation of the yen, such as the appreciation seen in the summer of 2024, would exert broad downward pressure on Japanese equities. He remarked, “Ahead of the September policy meeting, there will be growing questions about whether the Bank of Japan should tighten monetary policy. If we see yen volatility suddenly spike again, that will be a drag on the market.”