Japan's equity market is no longer merely in a cyclical recovery. Behind its performance since 2023 lie higher nominal growth, a changed inflation regime and a reordering of capital allocation. The reform agenda of Japan Exchange Group (JPX) is accelerating a shift that was long in coming: companies are now judged far more closely on their return on capital, their valuation and the value they create for shareholders. At the same time, the environment is becoming more demanding. The Bank of Japan is no longer trying to push inflation up; its concern now is to stop it overshooting the 2 per cent target1. As monetary policy normalises, the bar for earnings power and valuation rises with it. Higher interest rates thus become a stress test: can earnings growth and sharper capital discipline carry the structural re-rating?
JPX reforms: capital allocation takes centre stage
What sets this cycle apart from earlier upswings in Japan is the market infrastructure itself. The Tokyo Stock Exchange (TSE) restructured its segments in 2022.2 In March 2023 it set a clear benchmark by calling for “management that is conscious of cost of capital and stock price”. Companies in the Prime and Standard segments are expected to analyse their return on capital and cost of capital, publish improvement plans and discuss their progress with investors each year.3
These requirements amount to far more than a call for higher payouts. Management teams and boards must set out how strategy, capital tied up in the business, balance-sheet structure and corporate value relate to one another. Tighter expectations have applied since April 2026, calling for a concrete medium- to long-term strategy, a clear link between the use of capital and the company's growth vision, portfolio optimisation and effective oversight at board level.4 In July 2026 the JPX streamlined its governance code from 83 principles to 30.5 Formal complexity is therefore falling, even as the demands on implementation grow.
At 98.8 per cent of Prime companies, at least one third of board members were independent in 2026. In a JPX survey conducted in June and July 2026, 74 institutional investors reported substantial progress at some 300 companies. Of the 682 companies surveyed, 75 per cent regarded their dialogue with investors as worthwhile.6
Remuneration structures are changing too. In 2026, 84.5 per cent of companies listed on the Tokyo Stock Exchange had introduced incentive-linked pay. At 50.7 per cent it was explicitly performance-based, rising to 72.7 per cent in the Prime segment.7 What ultimately matters, however, is whether metrics such as return on equity (ROE), return on invested capital (ROIC), cash flow and strategic milestones are set at demanding levels and disclosed transparently.
Index architecture is adding further pressure. The TOPIX has been slimmed down from around 2,200 constituents to 1,638 and is due to shrink in stages to 1,050 names from July 2028.8 The unwinding of cross-shareholdings – reciprocal stakes held by companies in one another – has also continued: according to Nomura, their share of market capitalisation fell to 9.7 per cent by financial year 2024, down from more than 50 per cent in the 1990s.9 Share buybacks, dividends, mergers, acquisitions and takeover bids are all on the rise.
New flows of capital are coming on top of this. By June 2026, assets held in the NISA framework stood at around 81.9 trillion yen across some 30 million accounts; in 2014 there were 4.9 million accounts.10 Between January and July 2026, foreign investors were net buyers of Japanese equities to the tune of 10.1 trillion yen.11 Domestic wealth accumulation, international interest and deeper liquidity are therefore underpinning structural demand for Japanese equities.
Inflation and interest rates: from special case to normalisation
The macroeconomic foundation is Japan's exit from the logic of deflation. The working-age population fell from around 86 million in the late 1990s to roughly 73.53 million in 2025. Over the same period, the number of people aged over 65 rose from around 21 million to about 36 million.12 Labour is becoming scarcer as a result.
Wage growth is now both broad-based and sustained. Figures from the Japanese trade union federation RENGO show base-pay increases of around 3.0 to 3.5 per cent for 2024 to 2026, with total regular wage increases of roughly 5.0 to 5.5 per cent.13 One-year-ahead core inflation has meanwhile run at between roughly 2.5 and 3.5 per cent.14 Wages and domestic prices are thus reinforcing one another. Higher nominal growth improves the revenue base, makes price increases easier to pass through and strengthens the case for productive investment.
The shortage of labour is also driving automation and the adoption of artificial intelligence. The principal beneficiaries are likely to be companies in industrial automation, components, semiconductor equipment and digitalisation, along with selected infrastructure and energy businesses.
Rising interest rates are the flip side of this normalisation. They push up funding costs and discount rates – the rates at which future profits are discounted back to their present value – and make a broad-based re-rating harder to sustain. What matters is how they compare with nominal growth and earnings power. Since 2023, nominal GDP growth has averaged 4.3 per cent.15 Analysis by Bank of America suggests that, historically, share prices gained the most momentum when nominal growth exceeded the yield on ten-year Japanese government bonds and the earnings yield remained roughly twice the yield on long-dated government bonds.16
Should Japanese government bond yields rise faster than the nominal economy, or earnings estimates come under pressure, this valuation anchor will lose much of its force. The most exposed companies would be those whose profits lie far in the future and which convert earnings into cash flow only weakly. Banks, insurers and parts of the financial sector, by contrast, tend to benefit from wider interest margins. Companies with solid balance sheets, pricing power and capital discipline are better placed to absorb higher funding costs. Stock selection is therefore becoming more important.
The government's investment agenda: another structural driver
The Takaichi government has announced that a combined 370 trillion yen of public and private investment is to flow into 17 strategic fields by fiscal year 2040. The focus is on physical AI (artificial intelligence embedded in machines and robots) and semiconductors, cloud computing and data centres, cyber security, 5G/6G, All-Photonics Networks (end-to-end optical networks), quantum applications, defence, advanced materials, biotechnology, energy and supply security, and resilience and space infrastructure.17 The sheer scale gives long-term investment plans greater visibility and could generate additional demand across several industrial and technology segments.
Seasonality: a tactical factor, not an investment case
Seasonal patterns can also play a part in the short term. In industrial recoveries accompanied by rising interest rates, the available analysis shows that the market has often been more volatile over the summer months before typically steadying from late September. That period also brings half-year results and possible revisions to company guidance. From here, the key variables are Japanese government bond yields, earnings revisions and the global industrial cycle.
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