More reasons for optimism will be given to investors over the medium term, if the corporate sector can deliver sustainable improvement in returns say Miyuki Kashima, Min Zeng and Judy Chen at Fidelity International.
A victory in snap parliamentary elections has handed Japanese Prime Minister Sanae Takaichi a strong mandate to boost the economy. Takaichi’s Liberal Democratic Party (LDP) now has more than two-thirds of seats in parliament’s lower house and with coalition partner the Japan Innovation Party, as many as 352 seats.
The question now is whether they can build successfully on the progress that has been made in extracting one of the world’s richest countries from a long period of deflation and stagnant growth.
Our view is that the election outcome is positive for Japanese equities, reducing policy uncertainty and raising the probability of near-term fiscal support for the economy.
Companies can plan capital deployment with greater confidence, and closer economic alignment with the US will encourage Japanese firms to participate more actively in overseas investment cycles.
A changing landscape
Long before this election, a major shift was playing out in Japan – a greater focus on capital efficiency, a transition toward moderate inflation, and improving corporate earnings – all adding up to a better landscape for investors.
After three decades of deflation, the economy shows signs of returning to “normal” levels of inflation. Companies are raising prices, wages are increasing due to a structural shortage of labour, and pricing power is re-emerging across a range of sectors.
At the same time, the Bank of Japan (BOJ) is normalising interest rates at a measured pace, helping anchor inflation expectations without choking off growth.
Japanese companies, which have long been criticised for poor corporate governance, have increasingly boosted shareholder returns. Since 2023, the Tokyo Stock Exchange has pushed companies to improve capital efficiency.
Dividend pay-out ratios are rising and management accountability is becoming more visible. Japan’s corporate governance code is due for an update this year, driving anticipation for more improvement in shareholder returns.
As the reforms deepen and the economy recovers, Japanese companies are on track for a structural improvement in profitability. After stagnating at around six to eight per cent for much of the 2000s and 2010s, average return on equity is projected to reach 10 per cent by FY2026 and 11 per cent by FY2028.
This sustained uptrend should narrow Japan’s valuation discount relative to global peers and reinforce the case for a long-term re-rating.
Strategic industries
Construction, semiconductors, infrastructure, and energy shares will see tailwinds as Takaichi’s government pledges trillions of yen in stimulus spending. The government released a plan late last year, focusing on bolstering 17 “strategic industries”, including defence, disaster prevention, cyber security, quantum computing, and nuclear fusion.
Financials are set to shine as they benefit from the BOJ’s gradual normalisation of interest rates and rising demand from companies for loans. Companies are also stepping up dividend payments and share buybacks, while cutting back on cross-shareholdings, boosting their attractiveness.
A host of challenges remain in the short term. Japan already holds the world’s largest debt load for an advanced economy. The government needs to fulfil pledges to cut taxes and increase spending without spooking bond investors.
A sustained rise in Japanese government bond yields could lift the equity discount rate, compress valuation multiples, and tighten financial conditions. In the coming months, the stock market will be particularly sensitive to how any fiscal package from the government is funded and how firmly any exit mechanisms are set.
But without doubt Japan will stand out for its policy consistency and reform momentum. If the corporate sector can deliver sustainable improvement in returns, it will give investors more reasons for optimism over the medium term.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
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