Japan’s equity market got off to a volatile start in 2025, buffeted by the impact of US tariff policy, and we also saw a sharp sell-off in early spring amid concerns over reciprocal tariffs. Looking back over the year as a whole, however, solid corporate fundamentals in Japan absorbed these external headwinds, and Japanese equities went on to set new all-time highs.
Many uncertainties remain—trade friction, a global economic slowdown and geopolitical risks, among others. At the same time, Japan is undergoing structural change, including a shift from deflation to a phase of moderate inflation and continued progress in governance reform, which has further strengthened the foundations for market growth. Against this backdrop, 2025 can be seen as a year in which the market rewarded the underlying resilience of corporate earnings and improvements in capital efficiency among Japanese companies.
A positive structural shift: moderate inflation and monetary policy normalisation
Japan’s economy is now clearly moving away from the deflation that persisted for many years. Deflation held back nominal GDP growth, heightened household anxiety about future income and made companies more cautious about investment. Today, however, alongside monetary policy normalisation, upward momentum in wages is creating conditions in which inflation can become more firmly established.
Japan’s core Consumer Price Index (excluding fresh food) in the first half of 2025 remained above 3%, but is expected to settle at around 2% towards year-end. The key point is that this is not runaway inflation; rather, it is a sustainable form of inflation driven by a combination of wage growth, recovering demand and policy measures. Real wage improvement is still a work in progress, but robust growth in nominal wages—led by the annual spring wage negotiations (Shuntō)—has spread across a wide range of industries. This should increasingly support consumption through rising household income. In a tight labour market, many companies also have little choice but to continue raising wages to secure talent, which is an important driver of a virtuous cycle between wages and prices.
On the monetary policy front, support for equities remains in place. The Bank of Japan (BoJ) has begun a gradual normalisation from its ultra-accommodative stance, but overall financial conditions remain loose. The Bank continues to operate cautiously—anchoring inflation expectations while seeking to avoid a sharp downturn in activity.
The BoJ positions the current normalisation as an adjustment “conducted within an accommodative financial environment”, taking great care over both timing and scale to avoid unduly cooling the economy. This approach aims to achieve price stability while sustaining economic growth, without unnecessarily suppressing investment and consumption. Fiscal policy and the government’s growth strategy are also being kept broadly aligned at a high level.
As a result of this careful policy management, market expectations for interest rates have remained stable and corporate funding costs have not risen sharply. In other words, a supportive financial environment for equities continues to be maintained.
Clearer evidence of structural improvement in corporate earnings and reform
Corporate performance is also showing increasingly visible structural improvement. In the first-half results for FY2025, the impact of Trump-era tariffs proved less severe than feared. In addition, price revisions and volume effects supported profits, leaving overall earnings trends resilient. The shift to an inflationary environment is also boosting nominal GDP, providing an additional tailwind.
Having relentlessly pursued cost reductions during the deflationary period, many Japanese companies now have a structure in which incremental revenue growth more readily translates into profit growth. This has been contributing to earnings expansion.
Consequently, progress against full-year guidance has exceeded historical averages, and the ratio of positive earnings surprises has reached a high level. On the back of these strong results, analysts have continued to upgrade forecasts, lifting 12-month forward expected earnings per share. Exchange rates play a role, but some observers also point to the possibility of double-digit earnings growth in FY2026.
Beyond earnings growth, improvements in capital efficiency are also gathering pace. Japan’s average corporate return on equity, which has long hovered around 6-8%, is forecast by some to reach 10% in FY2026 and 11% by FY2028. Corporate profitability is being lifted by a combination of internal factors such as management reform and initiatives to improve capital efficiency and external factors, including a more supportive market environment. With both sets of drivers reinforcing one another, the likelihood of a sustained uplift in valuations for Japanese equities is increasing.
Regulatory and market reforms are reinforcing companies’ drive to improve capital efficiency
Alongside stronger earnings, institutional reforms are advancing and further supporting companies’ own initiatives. As the government and the Tokyo Stock Exchange (TSE) continue to strengthen the framework, Japan’s Stewardship Code was revised in 2025, with a review of the Corporate Governance Code also scheduled for next year. These standards are designed to make dialogue between companies and investors more substantive and to encourage a shift towards management that is more conscious of the cost of capital.
TSE-led reforms have also clarified the criteria for assessing capital efficiency and increased pressure to reduce policy shareholdings. In this sense, governance reform is deepening—from formal compliance towards genuine improvement.
In response, corporate reform is steadily moving forward. Companies are accelerating efforts to enhance capital efficiency, including reviewing financial structures, restructuring low-profit businesses and strengthening investor engagement. Shareholder returns are also expanding through both buybacks and dividends. Buybacks, in particular, surged in 2024, up by around 90% year on year, and have remained high in 2025. Dividend payout ratios are moving closer to international standards, and the stance of cash-rich companies is being reconsidered, signalling a structural shift towards more effective use of capital.
In addition, the unwinding of listed parent–subsidiary structures is improving transparency across corporate groups and better aligning interests with shareholders—contributing to an overall rise in market quality.
Political continuity is also a supportive tailwind for Japanese equities
Politically, a change of administration drew attention. We view this as a natural process within Japan’s stable democratic system, and not something that should automatically be treated as excessive risk. Although the Takaichi administration is a coalition government without a majority, it is maintaining the pro-growth policy stance and reform agenda to date. The continuity of policy has been positively received by the market.
The government’s core economic approach emphasises both strengthening growth potential and maintaining stability in fiscal and macroeconomic management. The direction is clear: raise Japan’s potential through strategic investment and measures that support demand. Japan has already moved into a moderate inflation environment and corporate earnings are improving; these policies should reinforce the durability of that trend.
Ongoing initiatives to revitalise capital markets and promote investment should also improve policy consistency and predictability for Japan, helping to create an environment that encourages corporate growth investment. If these policies take hold, overseas investors may increase allocations to Japanese equities. Furthermore, as policies aimed at becoming an “asset management nation” progress, there is potential for Japan’s substantial household savings to be channelled into investment. Domestic investors still hold large cash balances compared with peers in the US and Europe; there is meaningful scope for these funds to flow into markets and, over time, become a powerful source of support for Japanese equities.
In this way, the Takaichi administration’s policy stance is expected to strengthen the growth trend already underway in Japan’s economy and to provide a medium-term tailwind for the Japanese equity market.
Structural change underpins continued relative strength in 2026
Taking all of this into account, the medium-term outlook for Japanese equities remains very favourable. Short-term risks persist stemming from US trade policy, as well as swings in overseas economic conditions and the international environment, but multiple positive factors should support the market’s upward trend: expanding corporate earnings, improved capital efficiency driven by governance reform, and the capacity for additional inflows from both domestic and international investors.
Supported by moderate inflation and ongoing structural corporate reform, Japan’s equity market appears well placed to deliver solid performance. Uncertainty in the external environment has not disappeared, but it is precisely in such conditions that Japanese equities may command greater attention as an investment destination that combines stability with growth potential.
