The devastation of war, economic miracle, economic collapse, and economic stagnation; name it, and Japan has gone through it all.
Economists have used Japan’s experience between the 1950s and the 1980s as an example of how economic transformation can sponsor sustained economic growth. Yet, they can turn around and use Japan as an example of how insufficient financial regulations and crony capitalism can cause economic collapse and precipitate sustained economic stagnation.
Japan’s stock market (represented by the Nikkei 225 Index) has also followed the ebbs and flows of the larger economy. Its size of the global stock market was more than 40% at the height of its economic transformation. But when its bubble burst, investors lost more than $2 trillion in just a year. The index would continue to make lower lows until it bottomed out in the Great Recession of 2009.
By 2012, Japanese equities moved from a downtrend to an uptrend. In February 2024, Al Jazeera reported that Japanese equities have become “the hottest game in town,” as they made a new all-time high (ATH), the first time since December 1989.
Since then, interest in Japan’s stock market has increased. Current developments in its economy and the global economy mean it’s time for investors to overweight Japan in their portfolios, according to GMO, an investment management firm.
But are Japanese stocks a good investment, or is this just the building up of another bubble that is going to burst? In this article, we will answer this question by considering the following:
- The highs and lows of the Japanese stock market
- What’s behind the revival of interest in Japanese equities
- Is it time for you to diversify into Japan?
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1. The highs and lows of the Japanese stock market
The economic miracle and a thriving stock market
A few years after the reopening of Japan’s equity market in 1949, the country experienced a long period of economic transformation (between the 1950s and the 1970s) that economists refer to as an economic miracle.
The impact of this economic miracle was felt in the stock market, as the Nikkei 225 Index went from 176.52 in May 1949 to a peak of 38,916 in December 1989.
Nikkei 225 Index, 1949-2024
Source: Macro Trends
Between January 1950 and December 1989, the index had a compounded annual growth rate of 16.74%, which was more than double the 7.95% CAGR delivered by the S&P 500 Index during the same period.
(Note: Past performance does not guarantee future performance)
Also, the Nikkei 225 Index went from being 15% of the global stock market in 1980 to 44.2% in 1988, according to the academic research done by William Ziemba and Sandra Schwartz, with both domestic and international investors savouring the Japanese miracle.
The bursting of the bubble
However, things took a bad turn when the bubble that had formed in the Japanese economy burst, and the Nikkei Index fell by 38.72% between the peak of December 1989 and December 1990. By the end of 1990, stock investors had lost $2 trillion, according to a report by The Guardian.
Loose monetary policies and a lackadaisical approach to regulations had caused speculation in stocks and real estate to rise to unsustainable levels. When the Bank of Japan (BoJ) raised interest rates, asset prices declined as the stock and real estate markets crumbled.
Banks, which had expanded credit based on the high values of real estate and stocks, suffered, and an extended period of credit crunch followed. The credit crunch would lead to lower aggregate demand and a sustained period of economic stagnation.
By 1992, the stock market had lost half of its value from its December 1989 peak. It would continue to make lower lows until it bottomed out at 7568.42 in February 2009, during the Great Recession.
Emerging out of the shadows
The tides began to turn when Abenomics (the economic policies of Shinzo Abe, Japan’s Prime Minister between 2012 and 2020) was introduced in 2012. Abe (supported by the BoJ) used expansionary monetary and fiscal policies to fight sustained deflation and economic stagnation. Many structural reforms were also introduced.
Between early 2013 and June 2022, the Nikkei 225 Index grew by more than 160% in Japanese Yen (JPY) terms (70% in USD terms), according to MSCI, a financial services firm. The chart below is a visual representation of this transformation:
Japan’s stock market returns, 1990-2012 vs 2013-2022
Source: MSCI
In 2023, the Nikkei 225 Index would go on to produce a 28.2% annual return, conveniently outperforming the S&P 500 Index, according to Al Jazeera.
It is no wonder, then, that foreign investors responded by buying ¥956 billion ($6.5bn) of Japanese equities within a single week in January 2024. The index grew by 8% in that month alone.
Al Jazeera attributed this renewed interest to a weak yen (which makes Japanese equities cheaper), corporate governance reforms, higher corporate profits, a boost in local investment, and rising wages, among others.
All of these factors would continue to act in favour of Japan’s stock market as it made a new ATH on February 22, 2024, for the first time since December 1989.
“For us traders, this marks the arrival of a new era,” according to Tsutomu Yamada, senior market analyst at Au Kabucom Securities, in an interview with Reuters. “It feels like the stock market is telling us that we've finally escaped from deflation and a new world has opened up.”
By March 4, 2024, it had crossed 40,000 for the first time, as reported by CNBC. It would end the year with a 19% annual return, just four percentage points behind the S&P 500.
2. What’s behind the revival of interest in Japanese equities
In March 2025, GMO, an investment management firm, exemplified the renewed interest in Japan in an article published on their website.
“In a world of rich valuations and heightened geopolitical uncertainties, we believe Japanese equities are well-positioned to deliver attractive returns,” they said. They would go on to advise that it is time for portfolio managers to increase allocation to Japan and even overweight Japan in their portfolios.
J.P. Morgan shares the same optimism.
“Outside of the United States, Japan stands out as our favourite market given its relative macro stability and safety amid global trade uncertainty,” they noted in February 2025. “We also see a variety of cyclical and structural tailwinds for its equity markets. We have been constructive on Japanese equities throughout 2023 and 2024, and despite back-to-back years of over 20% annualised returns, we continue to maintain our multi-year positive thesis on the market.”
There are at least four factors encouraging investors to see Japanese stocks as longer-term plays:
Improving macroeconomic backdrop for Japanese companies
The inflationary pressure that accompanied and followed the COVID-19 pandemic precipitated a rise in nominal wages, which is well poised to lift Japan from its “deflationary malaise,” according to GMO.
As the chart below from J.P. Morgan shows, inflation has exceeded 2% for four consecutive years for the first time in decades:
Japan’s Inflation Rate, 2015-2024
Source: J.P. Morgan
Similarly, there is a forecast that economic growth (nominal GDP) for 2025 will be 3.4%, which would be higher than the 1.6% average between 2013 and 2019.
Finally, Japanese companies continue to deliver EPS growth that exceeds the nominal GDP growth in the economy. This is the exact opposite of what happens in the US, as the chart below shows:
Local EPS and Nominal GDP Growth, Japan vs US
Source: GMO
Comparatively, the EPS of Japanese companies (represented by the stocks in the Tokyo Stock Price index [TOPIX]) tracks with that of US companies and conveniently exceeds that of European companies.
EPS of Japanese, American, and European Stocks
Source: J.P. Morgan
Corporate reforms
Company managers, propelled by Tokyo Stock Exchange, are more open to the need to improve return on equity and provide more value to shareholders.
As the chart below shows, the YoY increase in ROE has been on a steady uptrend driven by “specific actions to reduce or sell loss-making businesses, improve operating efficiency, and increased competitiveness due to a weaker currency,” according to J.P. Morgan.
YoY Growth of the ROE of Japanese Companies
Source: J.P. Morgan
Regarding shareholder value, Japanese stocks are going beyond dividends by embracing share buybacks as a way to return money to shareholders. A total of ¥16.8 trillion was spent on buybacks in 2024, a 75% year-on-year (YoY) increase, according to GMO.
Furthermore, the unwinding of cross-shareholdings has proceeded apace, and many companies are now open to change of control through local and foreign takeovers. Unsolicited bids have also lulled many managers from sleep to focus on operational efficiency, better value to shareholders, and improved shareholder communication.
Attractive valuations and solid fundamentals
For value investors, investing in Japan is a good way to buy valuable companies for cheap. “The market is relatively cheap, trading at 15 times forward earnings, about where it was a decade ago, and events on the horizon could give it a boost,” according to Barrons, a financial publication.
Many Japanese companies also have strong balance sheets, even as high earnings growth continues to boost shareholder value and share price, according to GMO.
Current underinvestment in the market
Both local and international investors are currently underinvesting in the Japanese market.
“The single largest buyer of Japanese equities since 2024 are Japanese corporates via share buybacks,” according to J.P. Morgan.
The chart below shows that locals still invest in cash more than equities, despite increase in equity investment in recent years:
Investment in Cash vs Equities in the US, Europe, and Japan
Source: J.P. Morgan
Also, GMO noted that the average international mutual fund is 6.9% underweight to Japan relative to the MSCI EEAE benchmark.
What’s the implication of these two facts?
“There remains meaningful scope for positive inflows into the asset class (Japanese equities), which could provide a potential tailwind,” according to J.P. Morgan.
3. Is it time for you to diversify into Japan?
So, are Japanese stocks a good investment?
Interestingly, much of the excitement about Japan we see in 2025 was already evident in 2024.
However, two factors ensured that investors didn’t get as much value at the end of 2024 as they projected at its beginning – the BoJ raised interest rates in August, and the yen weakened.
Thus, before joining the excitement in 2025, it is wise to consider what effects those two factors will have this year.
Also, no serious investment discussion can be had in 2025 without factoring in the global trade situation following Trump's tariff policy.
While considering if investing in Japan is a smart decision, we must consider these three factors.
The impact of Trump’s tariffs
Interestingly, Japan has not had so much news time since the whole tariff business started. China, the EU, Mexico, and Canada seem to be the ones with most of the attention.
Yet, this does not imply that Japan will be free from the impacts of a potential global trade disruption.
Some of the areas of concern for Japan, according to CMO, include: US-China trade war putting a strain on Japan’s competitiveness and disrupting supply chain, devaluation of the USD reducing the profitability of Japanese companies, slower global growth causing growth disruptions in Japan.
J.P. Morgan also mentioned that Japan has a trade surplus with the US (and Trump is targeting countries the US has a trade deficit with) and that there is uncertainty on Japan-US alliance given that Trump is dealing with Prime Minister Ishiba for the first time.
Furthermore, exports make up 20% of the GDP of Japan and exports to the US are 20% of total exports. Finally, trade uncertainty could depress manufacturing activity and business investment in Japan.
Nevertheless, there are reasons to be hopeful that Japan can weather current trade uncertainty:
- Japan and the US have maintained a good relationship since the whole Tariff fiasco started. Trump has asked that Japan deal with the trade surplus by purchasing US oil and gas, a move that Japan seems to be fine with.
- Japan’s trade surplus with the US has declined a bit over the past two decades and it is lower compared to China and Europe.
- Japan is the largest FDI investor into the US over the last decade.
Top FDI Investors into the US
Source: J.P. Morgan
More important though is the point made by both GMO and Barrons: the effect of Trump’s tariffs will be disproportionate on Japanese companies, with some losing and some gaining. This means investment opportunities will always abound.
Japanese exporters that set up shops in the countries where they sell their products could benefit as they focus attention on where wage growth is higher. Similarly, those who concentrate on the local market will benefit from rising wages and mild reflation.
Also, those who sell products not affected by tariffs to the US should be fine. Finally, Japanese companies that have been offshoring production out of China and diversifying their export markets will not be negatively affected.
This implies that asset owners and managers concerned about the impact of trade disruptions may have to do a deep dive and select individual stocks rather than entire indices.
Will the yen weaken or strengthen?
The Japanese yen has been strengthening against the US dollar throughout 2025. Factors responsible for this include economic uncertainty in the US, increasing perception of the yen as a potential safe haven, and monetary policy actions by the BoJ.
USD/Yen Exchange Rate
Source: Google Finance
This trend is positive for foreign investors in Japan’s equity market.
But can this trend be expected to continue?
“Further strengthening of the JPY will likely require another step down in U.S. rates, potentially driven by a more dovish Fed or a downward revision in the U.S. macro outlook,” according to J.P. Morgan.
In his recent public statements, Jereme Powell, the chair of the Federal Reserve, said that there is a real stagflation threat in the US. From a policy perspective, this means we can’t be sure if the Fed will lower rates to encourage growth or raise it to combat inflation.
Thus, there is no guarantee that the current strengthening will continue (or not).
If you are certain it will not continue (due to the fundamental strength of the dollar and the US economy), you can always hedge your exposure to Japanese equities. This turned out to be the smarter choice in 2024, according to Barrons: “The iShares MSCI Japan ETF, which isn’t hedged, barely returned 7% last year, compared with 30% for the WisdomTree Japan Hedged Equity Fund.”
Also, while it has strengthened against the US dollar (and the Chinese yuan), the yen has weakened against the Euro and the Swiss Franc. If that trend continues, then investors from these countries will also benefit from hedging.
Similarly, GMO notes that many Japanese multinationals hedge their bottom lines against the effects of currency fluctuations. Thus, they should continue to generate strong earnings irrespective of what happens to exchange rates.
Even if the yen weakens, many Japanese companies will benefit from it. For example, Barrons see tourist business benefitting from the wave of tourists that a weak yen will attract.
Therefore, In addition to (or as an alternative to) hedging your portfolio, you can also focus on companies who will benefit from a weaker yen and/or those whose earnings are properly hedged against currency fluctuations.
Finally, you may choose to follow the lead of J.P. Morgan in their current preference for investing in Japan without a hedge because they see the yen (given its safe-haven asset) in itself as a hedge against geopolitical uncertainty and a tool for portfolio diversification.
What will the BoJ do?
The BoJ increased interest rate in January, and this was one of the factors that contributed to a stronger yen.
However, they affirmed a commitment to gradual normalisation in May, given the need to balance inflation control and economic growth.
There doesn’t seem to be a reason to increase rates further. And if global economic conditions improve (especially with the US and China coming to a lasting trade agreement), a rate cut may even be in the offering.
On the other hand, J.P. Morgan notes that pressure to keep strengthening the yen (by the US and local politicians) could lead to fresh interest rate hikes.
For asset owners and managers investing in Japan, it all boils down to the impact of interest rate actions on the relevant exchange rate. If your expectation is higher rates, hedging may become more important. Also, you may need to focus on companies with proper hedging tools for currency fluctuations.
Are Japanese stocks a good investment then?
From all we have seen, the fundamentals seem strong. However, investing in Japan requires that you pay attention to the three factors highlighted above – monetary policy, exchange rate, and global trade.
Though these factors are not defeaters for the thesis that Japanese stocks are a good investment, they require that you focus on stocks with certain characteristics and embrace an investment strategy well adapted to deal with these risks.
Investing in global markets requires that you keep abreast of the latest developments that can affect your investment decisions. One way to do this is to share ideas with and gain insights from other institutional investors.
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Takeaways
- Japan’s stock market has rebounded after decades of stagnation, hitting all-time highs for the first time since 1989.
- Investor interest is surging, driven by corporate reforms, strong earnings, and attractive valuations.
- Risks remain, including yen volatility, BoJ policy shifts, and global trade tensions. Sound investing requires managing these risks.
- Selective investing may be key. Investors should try and focus on well-hedged companies or those poised to benefit from current trends.
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