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Thought of the day

Japanese equities rallied to an all-time record high on Tuesday, advancing after victory for the ruling Liberal Democratic Party (LDP) became clear. LDP leader Sanae Takaichi on Tuesday made history by becoming Japan’s first female prime minister, following a coalition deal struck with the Japan Innovation Party (Ishin) and three independent lawmakers. The new government is widely expected to pursue expansionary fiscal policies, with a focus on economic revitalization and targeted support for small and medium-sized enterprises.

The yen weakened modestly on the news to 151.5 against the dollar, and the Nikkei 225 gave back early-session gains to end up just 0.1% after the vote result. Still, following Monday’s 3.4% surge, the index finished Tuesday at a record closing high. With the major domestic political question now resolved, investors may next turn their attention to external risk catalysts. Fragile US-China relations, global tariff policy, President Trump’s end-October state visit to Japan, and the subsequent APEC summit could all influence market sentiment.

Still, with our domestic investment thesis largely playing out as expected, we think the Japanese equity rally has room to run higher:

Pro-growth policies are now likely, but the details will matter: The “Takaichi trade” has driven equities higher. But we think further gains will depend on credible policy delivery and coalition stability. The new administration is expected to roll out a series of pro-growth strategies, including tax cuts, subsidies, and measures to boost earnings growth for Japanese companies. While coalition partners have divergent priorities around areas like social insurance reforms and nuclear policy, we think the parties are mostly aligned on fiscal and stimulus plans.

Higher return on equity could unlock rerating: After this latest leg of the rally, Japan’s forward price-to-earnings ratio stands at 15.7x, near the upper end of its historical range. Still, with global valuations trending higher, we think Japanese equities remain attractive on a relative basis. Ongoing structural reforms, including unwinding cross-shareholdings, accelerating share buybacks, and business portfolio restructuring, are driving improvements in return on equity (ROE) and profit margins. The Tokyo Stock Exchange’s push for higher returns on equity is also prompting companies to focus on efficiency and shareholder returns, supporting the case for a longer-term rerating. For global investors, we believe these domestic reforms are increasingly recognized as key drivers of future alpha.

Monetary policy tightening may be gradual: The Bank of Japan (BoJ) is expected to revise its growth forecasts upward at its next policy meeting, according to Reuters, reflecting resilience in the domestic economy and a more benign global trade backdrop. While gradual rate hikes are likely, including a hike in either December or January, we think the pace of hikes after that may be slower than previously anticipated in part due to public lobbying from the new prime minister for a more dovish monetary stance. The pace and strength of further normalization will also depend heavily on global developments, particularly US growth and tariff dynamics.

So we keep our Attractive rating on Japanese equities and position for further upside in the months ahead. In terms of domestic sectors, we favor IT services, real estate, and medtech in the near term, while defense, semiconductors, AI-related firms, industrials, machinery, and materials should benefit from government policies over the medium term. Our quarter-end USDJPY forecasts remain at 152, 150, 148, and 145 through September 2026.