Japan’s equity market history is marked by extremes. Following the asset bubble of the late 1980s and its dramatic collapse, the market entered a prolonged “lost decade”, weighed down by deflation, balance-sheet repair and weak domestic demand. While periods of recovery followed, they were often short-lived and vulnerable to global shocks.
A turning point emerged with the introduction of Abenomics in the early 2010s. Aggressive monetary easing, fiscal support and structural reforms helped stabilise growth and revive corporate confidence. Since then, Japanese equities have delivered reasonable returns in local currency terms. However, for Swiss and other international investors, a persistently weak yen has diluted those gains, contributing to lingering scepticism toward the market.
A cyclical market with global exposure
At its core, Japan remains a cyclical equity market. The composition of the MSCI Japan index reveals a clear bias toward industrials, financials, consumer discretionary and technology — sectors that are closely tied to the global economic cycle. Many of Japan’s largest companies are export-oriented and deeply embedded in global supply chains.
See also: Toyota issues lower outlook on Iran conflict supply impact
Historically, Japan’s relative equity performance has moved in line with global trade and manufacturing activity. Over the long term, Japan’s equity underperformance versus other developed markets tracked its declining world export share, as competitiveness eroded in key industries. In the short term, however, equity performance remains highly sensitive to changes in global growth momentum, as reflected in purchasing managers’ indices (PMIs).
Technology, automation and the AI angle
One area where Japan stands out today is industrial technology. The country plays a central role in global semiconductor equipment, factory automation, robotics and precision machinery. These strengths position Japan as a key beneficiary of renewed investment in automation and so-called “physical AI” — the integration of AI into machines and industrial processes.
See also: Japan issues ‘final’ warning before intervention, lifting yen
As global demand for semiconductors and advanced manufacturing equipment rises, Japan’s technology-heavy industrial base provides an additional cyclical tailwind.
Beyond global factors, domestic policy has also turned more supportive. Fiscal stimulus in Japan was already expected to be positive ahead of LDP’s landslide win, and current projections suggest that the fiscal impulse could exceed that of several European peers. This provides short-term support to growth and earnings, particularly in policy-sensitive sectors.
At the same time, sustainable reflation would break Japan’s deflationary psychology, lifting nominal revenues, margins, and investment after decades of stagnation. Improving domestic PMIs already point to a cyclical upswing in Japanese corporate earnings.
Valuation remains a nuanced part of the Japan story. On an absolute basis, Japanese equities are trading above their own long-term historical averages. This reflects improved profitability, stronger earnings momentum and rising investor interest.
However, in relative terms, Japan continues to trade at a meaningful discount to global equity markets. This low ROE reflects deep structural issues such as inefficient capital allocation, cross-shareholdings, and conservative management practices which are compounded by a sector mix tilted toward cyclicals rather than high-margin growth areas.
Corporate reform as a structural catalyst
Corporate reform is the most important structural pillar of the Japanese equity story. For decades, Japanese companies prioritised stability, market share and employment over shareholder returns, resulting in low profitability and large cash balances. Cross-shareholdings and insider-dominated boards further insulated management from market discipline.
For more stories about where money flows, click here for Capital Section
This landscape is changing. Regulatory initiatives — led by the Tokyo Stock Exchange, the Financial Services Agency and stewardship codes — are pushing companies to improve capital efficiency, justify balance-sheet structures and strengthen board independence. Since the mid-2010s, average ROE has risen materially compared with the pre-Abenomics period.
Despite this progress, significant room for improvement remains. Lower margins, asset turnover and cash efficiency continue to differentiate Japan from US peers, suggesting further upside if reforms continue to gain traction.
One visible outcome of reform has been a sustained increase in shareholder payouts. Dividend yields in Japan have risen over time, while global dividend yields have generally declined, narrowing the historical gap. In parallel, share buybacks have surged, reaching record levels in recent years.
M&A activity has also increased, though it remains below levels seen in other developed markets. Reduced cross-shareholdings and rising foreign ownership — now around one-third of the market — suggest a gradual but meaningful shift toward a more market-driven corporate culture.
Key risks to monitor
The investment case is not without risks. Policy execution remains critical, particularly in sectors that have already priced in fiscal support. Monetary tightening by the Bank of Japan introduces uncertainty, even if history suggests that Japanese equities can perform during rate-hiking cycles.
Currency dynamics are another key consideration for Japanese equities. Since the mid-2000s, a weaker yen acted as a reliable tailwind for Japan’s export-driven market. Today, with overseas revenues at roughly 40% of sales, profits remain highly sensitive to exchange rates. However, this relationship has started to shift with the exit from yield curve control. Rising yields have reduced carry-trade incentives, and in February, the yen-equity correlation turned positive for the first time in over 20 years (equities rose alongside a stronger yen). If sustained, this could mark a move toward a secular bull pattern, where equities and the currency can rise together during positive macro periods.
Finally, Japan’s high dependence on energy imports leaves the economy vulnerable to oil price shocks, which could reignite already underlying cost-push inflation and weigh on growth.
Japanese equities are no longer defined solely by their past. A combination of domestic cyclical tailwinds, global technology exposure and deep-rooted corporate reform has materially improved the market’s fundamentals. While valuations are no longer cheap in absolute terms, relative discounts and structural change continue to offer potential upside.
For investors, Japan today represents a market in transition — one where disciplined policy delivery and sustained reform will be key to turning renewed interest into lasting performance.
Clémence Rusek is senior investment strategist at Vontobel
