Japanese equities: tomorrow has arrived

Japanese equities have hit an all-time high. A combination of international and domestic forces is driving the surge. Global investment funds are diversifying away from the US and China and into Japan. The US-Japan trade deal was less punitive than feared, resulting in 15% tariffs rather than the expected 25%. This compares favourably with China and other developed nations.

Decades of structural changes in Japan’s boardrooms are finally bearing fruit. Businesses have been pressured – through a ‘name-and-shame’ initiative – to sell underperforming divisions, simplify their structures, and return capital to shareholders. Latent value has been unlocked. We believe this focus on profitability is here to stay. Meanwhile, domestic investors, both retail and institutional, are snapping up Japanese stocks. Inflation has returned. Wages have risen for the first time in three decades. And last year, the country expanded its tax-protected investment scheme, unleashing a wave of capital into the market.

So, the big question: can the rally last?

Domestic revival: a virtuous cycle begins

After decades of stagnation, Japan’s domestic economy is showing signs of genuine transformation. Inflation has returned and wages are rising. Households have vast savings to spend. Labour shortages are encouraging long-overdue investment in automation and productivity-enhancing technologies.

High-quality retailers like Ryohin Keikaku, the owner of Muji, are thriving – up 100% this year – as domestic consumption rebounds. Technology firms like NEC, up 64%, are riding the wave of digitalisation.

Engineering edge: Japan’s global advantage

Amid rising geopolitical tensions and efforts to reduce reliance on Chinese supply chains, Japan’s engineering expertise is in high demand. As the US scrambles to rebuild industrial capacity, Japanese firms are stepping in. From robotics to machine tools, Japan is supplying the backbone of the next industrial cycle.

DMG Mori, a global leader in cutting machinery, is up 41% year-to-date, benefiting from reshoring trends and reduced competition from China.

Governance gains: unlocking hidden value

Corporate Japan is finally shaking off its reputation for inertia.

Take Asahi, up 18% year-to-date. Long known for its strong brand and cash-rich balance sheet, the company has committed to a 40% dividend payout ratio. This is the kind of tangible shareholder reward that was once rare in Japan. Now, it’s becoming more common.

Carry on yen: currency strength as a tailwind

The yen is up around 7% versus the US dollar this year, but the impact on equities isn’t straightforward¹. A stronger yen doesn’t necessarily mean weaker stocks, especially for companies with resilient business models and pricing power.

Three interlinked forces are driving yen strength:

Debt myths: why Japan isn’t the next US

Japan’s debt-to-GDP ratio may appear alarming at around 211%, but the picture is more stable than it seems. After accounting for government reserves, the figure drops below 100%, and the bulk of the debt is held domestically. Japan also benefits from some of the lowest debt-servicing costs in the developed world¹.

Unlike the US or UK, Japan is a net exporter with improving government finances. Tax revenues are rising faster than debt servicing, and the country is close to achieving a primary fiscal surplus. In short: Japan’s fiscal position is stronger than it looks – and far more sustainable than many of its peers.

Politics: all change at the top

Japan’s Prime Minister Shigeru Ishiba announced his resignation on 7 September, triggering a Liberal Democratic Party leader contest, scheduled for early October. This follows the party's defeat in July's election, which left the ruling coalition without a majority in either House of the Diet. Front-runners for the leadership nomination include Sanae Takaichi, former economic security minister, and Shinjiro Koizumi, agriculture minister.

Expectations of fiscal stimulus expansion under the new leader have led to steepening of yield curve and weakening of yen, while lifting the stock market. We do not expect major policy changes, as the ruling coalition will need to continue to cooperate with opposition parties on a bill-by-bill basis to pass legislation.

What does it mean for investors?

Japan’s equity market rally is built on solid foundations: domestic growth, global demand for engineering, rising inflation, corporate reform, and fiscal resilience. Combined with the yen carry trade, Japan is once again a compelling destination for active management.

Opportunities abound. The market may have run hard, but the drivers are at an early stage. Japan has a history of rapid change. And this time, the change is sticking.

Company returns: Bloomberg to 15 August 2025.

Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.