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Thought of the day

Japanese equities cheered a historic supermajority election outcome for Prime Minister Sanae Takaichi’s ruling coalition, with the Nikkei 225 and Topix surging 3.9% and 2.3%, respectively. The early election gambit earned the PM the largest lower house win since 1945, giving the government unprecedented political room for policy action, with two years until the next upper house election and four years until the next general election.

Bond and FX markets showed little evidence of fiscal anxiety: 30-year Japanese government bond (JGB) yields only briefly spiked to 3.62% before easing back to pre-election levels and early yen weakness gave way to gains, with USDJPY steadying near 156.6. The scale of the LDP’s victory, with 316 of 465 seats, hands Takaichi a powerful mandate to pursue her economic agenda, including tax relief and fiscal expansion, and opens the door to constitutional changes.

We view this as a market-positive outcome, signaling the “Takaichi trade” is back in full force. Markets will now refocus on how the new government will balance its proactive fiscal stance with the need for discipline, as the Diet reconvenes on 18 February and budget discussions begin in March.

With the benchmark Topix index up nearly 20% since September, some investors may be tempted to take profit. But we believe the rally has further room to run:

Earnings growth and reform momentum remain robust. Japanese equities are still anchored by solid fundamentals. Earnings momentum is strong, and the shift toward “good” inflation as real wages recover is a significant positive development, in our view. Profit growth is set to accelerate from 4% in FY25 to 10% in FY26. Valuations have moved up, with forward P/E now at 17.3x (above the historical 12-16x range), but we expect rising ROE to justify a higher market multiple. The end of tariff-related earnings drag should also lift corporate profits into next year.

Supermajority win should spark renewed foreign inflows. Historically, strong mandates in Japan have attracted global capital. Overseas investors have turned net buyers since Takaichi became LDP leader, but their overall exposure remains neutral, leaving room for further inflows. In the 100 days after major ruling party wins (Koizumi in 2005, and Abe in 2012 and 2014), the Topix averaged gains close to 20%. We think a stable, reform-minded administration will be appealing to international investors.

The election is just the start, with multiple catalysts ahead. A strong Takaichi mandate should reinforce confidence in Japan’s reform trajectory, with tangible steps on corporate governance reform expected in June. Topix reforms this October will reshape index composition and weighting, favoring companies with higher free-float market capitalization and better governance, enhancing liquidity, capital efficiency, and international appeal.

So, we keep our Attractive rating on Japanese equities and see scope for further upside, especially in sectors benefiting from domestic policy (defense, banks, real estate, IT services) and global themes (power, data centers, automation, select autos). On the USDJPY, authorities have already signaled a high sense of urgency around currency moves, which should tamp down pressure on the yen. We maintain our forecasts for the USDJPY to trend lower as fiscal risk premiums subside, targeting 155 by end-March and 148 by year-end. In the near term, JGB yields are likely to edge up on concerns over fiscal expansion under Takaichi’s strengthened mandate. But as the government’s policy direction on fiscal sustainability becomes clearer from April onward, we expect yields to stabilize.