Our overall outlook on the Japanese equity market is still positive, supported by factors beyond the corporate reform story that is creating greater shareholder value.
Positive wage growth should support Japanese equities
Last year, Japanese equity performance benefited from corporate reform initiatives aimed at enhancing governance and shareholder value. These programmes have achieved some success, leading to increased dividends, a rise in stock buybacks, reductions in cross-shareholdings, and improvements in return-on-equity and price-to-book ratios across the Japanese stock market. However, while initial data shows positive results, these corporate reforms are ongoing and the impact will take time to unfold.
In the meantime, the case for investing in Japan is still supported by several other drivers beyond corporate reform. One key positive is the pick-up in wage growth, which could potentially lead to a sustained increased in consumer spending. Although current wage growth is modest, real wages are still expected to rise in 2025, which should boost domestic consumption and, in turn, Japan’s growth prospects.
Wage increases should be supported by positive corporate earnings results and higher inflation expectations. Wages are typically negotiated annually in the spring during the "Shunto" discussions between corporate management and labour unions, and are heavily influenced by last year’s inflation rate. Current developments in this regard lean to the positive.
Stimulus measures are positive for Japanese growth
In terms of the local political landscape, the story is mixed. Concerns about the stability of the Ishiba administration persist due to its limited negotiating power both domestically and internationally. A minority government after the disappointing election results, the administration is expected to seek cooperation from opposition parties, such as the Democratic Party for the People (DPP), to gain support for implementing fiscal stimulus policies.
The government's new economic package focuses on tackling inflation, which has been a key concern for consumers. The announced stimulus plan is slightly larger than last year’s, and is likely to have a positive impact on the Japanese economy. Key pillars of the stimulus plan are aimed at addressing the rising cost of living and providing a sense of security. The package totals JPY 21.9 trillion in fiscal outlays, aligning with Prime Minister Ishiba's pledge for a larger extra budget compared to last year. With private sector financing included, the total package size reaches JPY 39 trillion.
The government expects the stimulus package to boost the size of the economy (gross domestic product) by approximately JPY 21 trillion and to increase the growth rate by about 1.2%. Of key interest is the extent of personal tax cuts, such as raising the annual earnings threshold for income tax from the current JPY 1.03 million. This adjustment in income tax brackets could prompt more part time workers to work longer hours, since the corresponding rise in income could still be exempted from income tax. The result could boost labour supply and contribute positively to economic growth.
The Liberal Democratic Party’s (LDP) weak election showing has increased pressure for more permanent tax cuts and populist measures. Opposition parties, such as the DPP, have made expanding tax deductions a condition for supporting the 2025 budget proposal. Ishiba and the LDP is expected to partially accommodate these demands, which means a likely stalling in the momentum to reduce government debt levels, at least temporarily.
Interest rates are rising, but slowly
On the monetary policy front, the Bank of Japan’s (BoJ’s) path towards normalisation remains influenced by US economic conditions and exchange rate trends. We think the BoJ will still aim to move slowly to a 1% policy rate and try to stop excessive yen depreciation. From 2022-2023, the relationship between yen strength and the performance of the Japanese equity market was weak. However, the relationship has recently shifted back to a strong negative correlation, suggesting a weak yen is still helpful for equity performance. Despite the short-term support to equities from yen depreciation, the BoJ is likely to take issue if currency weakness causes imported inflation and depresses domestic activity.
One major uncertainty Japan faces is the trajectory of regional trade amid rising US-China trade tensions. In addition to the direct negative impact on Japan from tariff increases by the US, a key trading partner, the intensification of US-China trade friction could indirectly harm the Japanese economy and key industries, such as the semiconductor sector, if the result is a downturn in the Chinese economy.
During Trump’s first term as US president in 2018, many Asian exporters of parts and components to China for re-export to the US were directly affected by tariffs on China. There will be some negative impact, but it will unlikely match worst case scenarios as Japan has shifted to offshore much of its production and manufacturing of goods to the markets where they are sold, instead of in Japan.
Investment implications
Our overall outlook on the Japanese equity market is positive. We see supportive factors beyond the story of the corporate reforms, based on wage growth and reflation, as well as the overall positive lean of government policy.
Normalisation of interest rates is a minor concern in our view. Even if the BoJ continues to raise its policy rate in the future, we believe that the accommodative environment should persist, limiting the potential for a significant negative impact on Japanese equities and the economy. Trade issues should also see only limited negative impact from US tariff and regulation changes.
As a result, the investment case for Japan still appears attractive, boosted by corporate earnings growth forecasts of around 7% for 2025, and supported by undemanding valuations, with price-to-earnings ratios close to average.