Investment houses have long been talking about a Japanese revival. And after more than three decades of false starts and deflationary stagnation, Tokyo’s stockmarket has finally broken free of its historical ceiling.
The Topix recently moved decisively above its 1989 peak, a symbolic shift that many investors see not as an anomaly but the beginning of a structural re-rating.
As the country elects its first female prime minister, the pro-business Sanae Takaichi, global asset managers argue that Japan’s underlying economic and corporate transformation is now too significant to ignore.
For Gary Paulin, chief investment strategist at Northern Trust Asset Management, the market’s breakout marks the end of one era and dawning of a new one. “When markets escape long-term range-bound periods, they tend not to stop there, they tend to rally for a number of years.”
When markets escape long-term range-bound periods, they tend not to stop there, they tend to rally for a number of years
Mr Paulin draws a historical parallel with the Dow Jones, which took 33 years to recover its 1929 peak but then compounded at double-digit rates for the following decade. Japan, he argues, may be at a similar inflection point. “Our job is to recognise change, and this is a big change.”
The catalyst, in his view, is a once-in-a-generation shift from deflation to inflation. “For years, Japanese corporates lived through deflation, over-indexing to cash and conservative accounting. Now, with inflation returning, companies are being pushed and incentivised to adopt more shareholder-friendly strategies.”
Those changes are visible in rising dividends, share buybacks, and a gradual improvement in governance and capital efficiency. “You’re seeing a lot more focus on buybacks and dividends; these things just didn’t exist before,” Mr Paulin adds. The combination of cheap valuations, cash-rich balance sheets, and reform momentum underpins Northern Trust’s long-term overweight to Japanese equities within its developed market allocation.
At the same time, Mr Paulin cautions that political turbulence, from leadership changes to coalition fractures, cannot be ignored entirely. “You can’t ignore the political noise, but much of the bad news is already priced into debt markets. In equities, other drivers are more dominant.”
Those drivers include megatrends such as ageing demographics, automation, defence and AI. “Technology, particularly around AI, and robotics linked to productivity are key,” Mr Paulin notes. “Japan is a world leader in robotic technology, and in the intersection of these long-term trends is where the real change lies.”
Continuity announcement
Some see continuity rather than disruption under Japan’s new political leadership. “We expect expansionary fiscal policy and continued monetary easing to drive a weaker yen and higher stock prices in the near term,” says Alexander Hart, equity specialist at Sumitomo Mitsui DS Asset Management.
The current index level, reflecting a price/earnings ratio of around 16x resembles the Abenomics rally, he says. “Structural reform progress and an eventual exit from deflation could justify 17x,” he adds.
While the short-term rally following Ms Takaichi’s ascent reflects optimism for fiscal stimulus, Mr Hart emphasises that the underlying trend remains anchored in fundamentals rather than politics.
“Even if expectations for the Takaichi administration wane, any stock price adjustments are likely to be temporary,” he believes. “The upward trend aligned with fundamentals should be maintained.”
Even if expectations for the Takaichi administration wane, any stock price adjustments are likely to be temporary
He expects the Bank of Japan to raise its policy rate in early 2026, once a positive wage-price cycle is confirmed. Fiscal measures under discussion, such as abolishing provisional fuel taxes, expanding local grants for wage increases, and investing in quantum technology, space and nuclear fusion, point to a pro-growth stance.
Policy support
Sector-wise, he identifies industrials, information technology and consumer discretionary stocks as key beneficiaries. “Defence equipment manufacturers, cyber security firms, and construction companies are likely to gain from policy support,” Mr Hart says.
While financials may face near-term headwinds from softer rate-hike expectations, balance-sheet maturity and reinvestment into higher-yielding bonds could improve return on equity and earnings per share, he believes.
For David Mitchinson, portfolio manager at Zennor Asset Management, Japan’s real story lies not in politics but in the gradual corporate governance turnaround. “We don’t expect a radical change under Takaichi,” he says. “Our focus is on the slower-burn governance revolution, the spin-outs, buybacks, dividends and M&A this is creating.”
Japan’s equity rally is not occurring in isolation, he notes. “Many global markets are rising, but Japan’s change is structural. For years, investors asked why Japanese stocks weren’t re-rated despite positive reforms; that’s now happening.”
For years, investors asked why Japanese stocks weren’t re-rated despite positive reforms; that’s now happening
Valuations, he adds, remain reasonable by global standards. Japan trades at 1.7x price-to-book versus 2.4x in Europe and 5.5x in the US. “It’s no longer cheap, but it’s not expensive either,” says Mr Mitchinson. Zennor’s approach is to avoid over-priced themes, notably AI and defence, and focus on undervalued companies with tangible catalysts.
Recent purchases in the fund include a brewery, a self-storage company and an automotive-parts supplier, hardly the headline-grabbing sectors of AI or nuclear fusion. “These may sound prosaic,” Mr Mitchinson says, “but they have strong balance sheets and meaningful long-term upside. We want companies trading below intrinsic value with positive change already underway.”
Japan’s policy continuity will sustain investment in defence, AI and nuclear energy, he acknowledges. “Takaichi is a supporter of AI and nuclear power. Firms like Fujitsu, NEC and Hitachi are well-placed, but valuations in some of these areas are already stretched,” he cautions.
AloJapan.com