Japan's stock market performance was a focal point in 2024 as the Nikkei surged to an all time high, but since then its performance has faltered and there are some doubts on whether it can get its mojo back this year
Japan emerged as a focal point for investors in the first half of 2024 as its stock market, notably the Nikkei 225, surged to a new all-time high, 34 years after its last peak.1 However, performance faltered from there. Can Japan regain its mojo in 2025?
In Japan’s general election in October the Liberal Democratic Party (LDP) and its coalition partner, Komeito, lost their majority in the lower house. The ruling coalition will now need to negotiate with other smaller opposition parties.
Without a majority there is greater uncertainty, and we are less likely to see a clear policy agenda. This is significant as a big driver of performance in Japan has been the stable political back drop and ‘Abenomics’ policies, which had helped to drive reforms in the country. There is a risk that Japan returns to its old ways where political indecision delayed necessary reform.
A key driver of the recent stock market performance in Japan has been the weakness of the Japanese yen versus other major global currencies, particularly the US dollar. Typically, when the yen falls the stock market rises. This is because the Japanese stock market has a bias towards exporting companies, whose profits get a boost from a weaker yen.
Having fallen in 2023 and first half of 2024, the downward trend in the yen was reversed when the Bank of Japan (BoJ) raised interest rates in August 2024. With Japanese interest rates expected to rise further in 2025, while falling in the US and other developed markets, money may flow back into Japan driving the yen higher. With the currency trading at historically low levels the yen could be at a turning point. It looks less likely currency weakness will support Japanese equities in 2025.
One of the underlying narratives shaping Japan's economic landscape is the push for corporate governance reforms. The government and the Tokyo Stock Exchange (TSE) are spearheading initiatives aimed at instilling genuine change within listed companies.
Corporate governance reform has been a central issue in Japan for over a decade. Originally the ‘third arrow’ of the late Shinzo Abe’s (former Prime Minister of Japan) economic revival programme it led to the introduction of the Japanese Stewardship Code in 2014.
These reforms have significantly boosted value for shareholders. Historically company management in Japan didn’t place much importance on delivering shareholder value and failed to listen to them. Companies have sat on large cash balances and not invested in their businesses - holding back growth.
There are signs these changes are beginning to work. Insights from Goldman Sachs reveal a correlation between companies' responding to these reforms and an improvement in their share prices. Companies embracing and effectively communicating their corporate governance changes have outperformed their peers, signalling a shift towards greater transparency and accountability.
Having been stuck in a deflationary cycle for most of the last three decades inflation has finally returned to Japan. Triggered by the global inflationary spike in 2022, it has become embedded in the country as the 2024 Shunto annual spring wage negotiations led to workers being given an average pay rise of 5.17%.2 This trend should continue in 2025 as the country’s key trade union, Rengo, is setting a 5% wage rise target for large firms and 6% for medium and small companies.3
Wage inflation has begun to feed into the economy, although modestly so. Despite this, it should support corporate profits and economic growth resulting in an above average growth rate for the country. Higher interest rates will impact borrowing costs, but this is likely to negatively affect growth in 2026.
The structural reforms have started to change corporate culture and could continue to provide a tailwind whilst higher inflation and rising interest rates might drive domestic investors into equities as companies offer the potential for growth. However, we could see the yen strengthen against the US dollar, impacting the stock market.
The political situation is opaque and there is a risk the willpower to deliver the structural reforms we have seen for the past 15 years has dwindled. The valuation of the Japanese stock market, based on their long-term price earnings ratio are fair value.
We are looking for a sustained improvements in company fundamentals and profitability to become positive on Japanese equities.
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