By Darius McDermott, managing director of FundCalibre
It’s been described as a ‘ninja rally’. After a slump in the export-heavy Japanese market in the wake of Liberation Day, the Nikkei has outpaced many of its peers in the intervening months. The rally appears to be supported by international and domestic investors alike and comes in spite of unexciting economic data, and a strengthening in the yen versus the dollar. What explains Japan’s popularity?
The Japanese economy has historically marched to a different tune to the rest of the world, but has started to behave more like a ‘normal’ economy over the past two years. After years of deflation, inflation has been picking up. Japan’s annual inflation rate has been hovering above 3% (3.1% in July 2025 from 3.3% in the previous month).
This has had knock-on effects in currency and bond markets. Japan’s interest rates have moved from a negative 0.1% to a positive 0.5%, their highest level in more than a decade. This has bumped up bond yields. The Japanese 10 year-bond yield is now 1.6%, also its highest level in a decade. This is a source of concern in a country with a debt to GDP ratio of over 230%.
However, GDP growth has been relatively encouraging. Japan’s economy expanded 0.3% in the second quarter of 2025 from the previous first three months, outpacing forecasts and the 0.1% growth seen in the first quarter. Part of the reason for the market’s recent rally appears to have been the resilience of the Japanese economy in the face of tariffs from the US.
It had been thought that the Japanese economy would be particularly vulnerable to tariffs given the importance of its export sector. In particular, a quarter of Japan’s US exports are from its critical automotive sector, which accounts for almost 3% of its economy. However, the US and Japan have now agreed a trade deal, with goods sold to the US taxed at 15%. It is still difficult for the automotive sector, but the country has avoided a worse-case scenario.
Overall, the picture is tentatively encouraging and there are implications for the corporate sector.
Positive momentum
Jared Anderson, manager on the Baillie Gifford Japan Trust, said: “The Japanese economy is continuing to see positive momentum following a prolonged period of deflation. Prices, wages, and interest rates are trending up. And in turn, the corporate sector is having to think harder about how capital is deployed and the return on that capital. This is a supportive backdrop for the types of companies we invest in and compounded by the structural growth themes that they are leaning into.”
The backdrop continues to encourage better behaviour from Japanese companies. They have already seen a significant improvement in governance in recent years on the back of government reforms. Poor practices such as cross-shareholdings and cash-hoarding, entrenched boards protecting sclerotic management teams, are being slowly ironed out.
The most recent government initiative “Action to Implement Management that is Conscious of Cost of Capital and Stock Price” from March 2023 led to a significant increase in share buybacks in 2024. Shareholders have become more active in the Japanese market, increasingly voting against companies with poor return on equity. This is a trend with many years to run.
Carl Vine, manager on the M&G Japan fund, said: “Corporate Japan continues to impress. Earnings grew by 9.8% this fiscal year, and companies announced a record ¥3.8trn in share buybacks this April – nearly triple the ¥1.3trn of a year ago. Japanese firms are set to repurchase 5% of their own shares, positioning themselves as the largest net buyers in the market.”
AI focus
The Japanese market has also benefitted from tentative moves out of the US by international asset allocators. For those investors looking for a more imaginative way to play the AI trend, away from US mega caps, there are options in Japan.
Anderson said AI and gaming have been standout themes in the recent rally. “This is evidenced by the likes of SoftBank, the technology-focused investment company, and Nintendo, the gaming and entertainment company”. SoftBank has assembled “an unmatched collection of AI assets”. It has a significant stake in Open AI, owners of ChatGPT, for example.
This is also a theme for the Comgest Growth Japan fund. Manager Richard Kaye said: “The growth of Asia, especially in areas where our companies provide indispensable semiconductor and automation supply chain technologies, as well as in consumer brand companies, should, in our view, be considered an integral part of the Japan story. Japanese equities offer an excellent way to capture that theme.”
He has recently been adding semiconductor exposure, through groups such as Lasertec and Disco, adding, “we are hearing that a new wave of replacement demand is emerging”.
It is worth noting the value factor has been very out of favour in Japan and it is possible that this may change as the yen normalises. Kaye says this is already starting to happen at the margins: “Companies with visible growth and multi-decade low price/earnings-to-growth ratios are being rewarded again.”
The recent rally has been supported by a broad spectrum of investors. Higher inflation has helped to encourage domestic investors out of cash and government bonds, while international investors have ploughed $35.7bn into the stockmarket this year, mostly after Liberation Day.
Strong company-specific dynamics
Vine added: “Japanese equities are regaining global attention. Even before factoring in idiosyncratic upside, the backdrop is compelling, in our view. Fortunately, company-specific dynamics remain strong – M&A, capital allocation and structural self-help are all accelerating.”
The Japanese market appears to have dodged a bullet on tariffs and the relief rally has been significant. The combination of the move out of US assets, ongoing corporate governance reform and the normalisation of the country’s economy may underpin further growth.
AloJapan.com