Japan’s stock market has recently delivered impressive performance, particularly after former U.S. President Donald Trump’s direct involvement in U.S.-Japan tariff negotiations. The yen weakened, and Japanese equities experienced a strong rally. Does this signal an ideal entry point for investors? Ivailo Dikov, a portfolio manager at Eastspring Investments, highlights three compelling reasons to be bullish on Japanese stocks and suggests shifting focus from large-cap to high-potential small- and mid-cap companies. By investing regularly in actively managed funds, investors may capture above-market returns.
Why Japanese Stocks? Three Key Drivers
1. Limited Tariff Impact, Strong Domestic Demand
Amid global trade uncertainties, Japan’s economy remains relatively insulated from tariff pressures. Dikov notes that domestic demand-driven businesses offer more stable earnings prospects compared to export-reliant firms, providing investors with resilient returns.
2. Robust Wage Growth Fuels Consumption
Japan’s nominal wage growth has reached a 30-year high, boosting disposable income and consumer spending. Dikov emphasizes that consumption is poised to become a more reliable driver of economic growth, benefiting domestic-focused companies.
3. Attractive Valuations and Solid Fundamentals
Despite global market volatility, Japanese equities present compelling valuations and strong fundamentals. Compared to other developed markets, Japanese stocks are reasonably priced, with corporate profitability and balance sheets in good health—making them a viable long-term investment.
Corporate Reforms and Small-Cap Opportunities
Beyond macroeconomic factors, Japan’s corporate reforms are unlocking additional upside. Companies are increasingly improving operational efficiency and shareholder returns. In 2024, share buybacks surged 75% year-over-year, reflecting corporate confidence. Notably, many small- and mid-cap firms hold significant cash reserves, suggesting continued buybacks and corporate actions could further lift the market.
While large caps have traditionally dominated investor portfolios, small- and mid-cap companies are gaining traction due to their agility, growth potential, and cash-rich balance sheets. Allocating to these segments may offer greater upside.
Investment Strategy: Patience and Valuation Discipline
Eastspring Investments’ Japan Equity Fund team adopts a patient, valuation-focused approach to capitalize on market opportunities. Key tactics include:
- Overweighting undervalued stocks: Adding to positions in unfairly discounted companies with unchanged fair-value targets enhances relative return potential.
- Identifying new opportunities: Screening for overlooked small-cap stocks with growth potential in lagging sectors.
Sector Spotlight: Industrials and Chemicals
Dikov highlights industrials and chemicals as promising sectors. While cyclical weakness in end markets has pressured earnings, valuations appear attractive relative to historical cycles. A demand recovery could drive meaningful upside.
Balanced Exposure: Exporters vs. Domestic Plays
Yen strength and trade uncertainties weigh on exporters, but recent sentiment shifts have made some valuations more appealing. Meanwhile, inflation and real wage growth should support consumer spending, benefiting domestic sectors. A balanced allocation captures opportunities in both areas.
Conclusion: Embracing Japanese Equities
Japan’s stock market has demonstrated resilience amid geopolitical shifts. Dikov’s three catalysts—domestic demand, wage growth, and valuations—underscore its appeal. With corporate reforms accelerating and small caps emerging as leaders, now may be an opportune moment to invest in Japan’s equity market.