In 2025, Japan was largely defined by trade tensions and tariffs. Toward year-end, however, markets were caught off guard by a second major surprise: the election of Sanae Takaichi as Japan’s first female prime minister (inaugurated on October 21, 2025). Often compared to Margaret Thatcher, Takaichi is widely viewed as an ultra-conservative hardliner. This outcome was not anticipated by markets. Backed by the right-wing Ishin Party, she prevailed over the previously favored Koizumi.
The potential for a “Takaichi rally” had not been priced in. Japanese equities reacted positively to the political surprise, with gains concentrated in growth-oriented segments. Following the presidential election the year before, the yen had appreciated sharply. This time, the currency weakened instead (October 6, 2025). Markets interpreted the outcome as supportive of a more expansionary fiscal stance under Prime Minister Takaichi. Her policy agenda provides greater visibility for a looser fiscal orientation and extends the time horizon for fiscal consolidation.
Fiscal Policy Shift and Monetary Policy Tensions
Growth stocks—especially technology exporters, defense, infrastructure, and energy—have moved into focus. Technology companies and defense contractors benefit from yen depreciation and government support for the semiconductor industry under Japan’s “economic security agenda.”
Financial stocks may face somewhat less near-term tailwinds should Takaichi support a more dovish monetary stance. Over the medium term, however, upside potential remains intact due to a steepening yield curve. The first meeting between BOJ Governor Kazuo Ueda and the new prime minister took place on November 12, 2025, in a broader group setting without direct bilateral dialogue. Markets are watching closely. A dedicated meeting would signal closer coordination between fiscal and monetary authorities.
Pressure on the BOJ remains elevated, with inflation still above target (September CPI: 2.9%). In addition, the prime minister has floated the idea of cutting the consumption tax, which would add to inflationary pressures. At its October meeting, nearly all BOJ board members expressed support for a rate hike in December (December 18–19). Until recently, a path of 25-basis-point hikes every six months was considered realistic, implying a terminal rate of around 1.5% by 2027. With a more expansionary government, the BOJ’s relationship with policymakers is becoming increasingly complex.
Nikkei Versus TOPIX: Growth Back in Favor
From an index perspective, the growth-oriented Nikkei 225 is likely to outperform the broader TOPIX under the Takaichi government’s policy agenda. This would mark a reversal of last year’s post-election market reaction.
Takaichi’s election as the first female leader of both the LDP and the Japanese government represents a structural inflection point. Expectations for reform and improved corporate governance are rising, and international attention is returning to Japan. Recent comments on Taiwan have also drawn strong reactions from China, underscoring Japan’s renewed geopolitical visibility.
From Outlier to Reform Market
In her public statements, Takaichi has set clear priorities. Historically, maintaining confidence in the stability of the financial system dominated fiscal decision-making. Under the new leadership, economic growth has gained prominence. In the short term, the “Japan discount” could narrow, potentially encouraging renewed international capital inflows into Japanese equities.
A key risk remains political execution. The ability to forge stable alliances on tax and budget issues will be critical; a minority government would pose a clear downside risk. Over the medium term, the sustainability of the positive momentum will depend on the implementation of announced reforms and monetary policy decisions. As always in politics, uncertainty remains—but the probability of a genuine reset has increased.
Why Japan Was Long a Special Case for Investors
Japan has long been an outlier—not only economically, but also in terms of investment strategies. Since 2000, momentum strategies have outperformed across most global markets. Japan was the exception: mean-reversion strategies delivered superior results.
The reasons are well known: persistently low growth and deflation, ultra-low interest rates, a fragmented industrial structure with limited scale effects, weak margins, excess liquidity, extensive cross-shareholdings, conservative balance sheets, and low returns on equity. Corporate governance standards were weak, payouts limited, and boards lacked independence. As a result, equity valuations were constrained within narrow ranges, and trends rarely persisted. This dynamic was reinforced by sluggish GDP growth, averaging just 0.7% annually between 1999 and 2021.
TSE Reforms as the Foundation for Higher Capital Returns
A turning point emerged in 2023, when the Tokyo Stock Exchange (TSE) launched comprehensive capital market reforms. The objective is to improve return on equity (ROE), raise price-to-book ratios, and enhance the global competitiveness of Japanese corporates. Measures include a reorganization of exchange segments, a stronger focus on capital efficiency, enhanced corporate governance standards, and mandatory disclosure of key information in English.
Historically, many Japanese companies suffered from poor capital efficiency. As of March 2023, around 43% of companies in the TOPIX 500 traded below book value, and roughly 40% generated ROEs below 8%. By comparison, the S&P 500 posted a price-to-book ratio of 4.5 and an ROE of 18% in 2023.
Early Evidence of Behavioral Change
The TSE reforms pursue three core objectives: increasing management focus on capital-efficient decision-making, raising corporate value and share prices, and restoring the confidence of international investors.
Companies with low price-to-book ratios are required to implement concrete measures to improve capital efficiency. These include divesting non-core assets, reducing cross-shareholdings, and critically reassessing business portfolios. Share buybacks and higher dividends are also expected, with an emphasis on sustainability rather than short-term financial engineering. Transparent communication with investors is a prerequisite. From July 2025 onward, all listed companies must maintain professional investor relations structures.
Since the reforms began, the share of companies trading below book value has declined. In the Prime Market, this figure fell to 44%, and in the Standard Market to 59%. ROE metrics have also improved, with fewer companies generating returns below 8%. These developments point to a meaningful shift in corporate behavior, with greater attention paid to cost of capital, ROIC, and WACC—and tangible implications for market valuations.
From Mean Reversion to Momentum
With improved governance and transparency following the TSE reforms, momentum factors have gained relevance in Japan, while mean-reversion strategies are losing effectiveness. Structurally higher inflation and stronger governance support nominal growth, allowing trend-following strategies to perform more in line with other global markets.
Balance sheet discipline and the unwinding of cross-shareholdings are delivering measurable results. Since 2024, liquidity within the TOPIX has declined by approximately JPY 7.5 trillion. Cross-shareholdings have been reduced by roughly 255 basis points of market capitalization, with the pace of unwinding since 2023 running about three times faster than before. If progress continues, ROEs could rise from 9–10% toward 13–15%, supporting a potential price-to-book re-rating of up to 75% over the medium term.
Reducing Fragmentation, Expanding Margins
Another reform focus is the reduction of industrial fragmentation. Companies with a clear core business tend to achieve higher margins and stronger governance than broadly diversified conglomerates. On average, Japanese firms operate across 2.4 sectors, compared with 1.5 in the United States.
If reform momentum persists and inflation remains structurally higher, Japanese equities could deliver long-term annual total returns of around 15% in local currency terms. Without reforms, returns would likely remain below 5%. Performance would be driven by revenue growth (inflation plus real GDP), margin expansion, share buybacks, dividend increases, and valuation normalization.
Conclusion: A New Investment Regime
Japanese equity performance remains closely linked to macroeconomic variables—particularly the yen, US interest rates, the CPI–PPI gap, and commodity prices. Portfolio allocation to Japan should reflect these drivers as well as the evolving political backdrop, including potential additional fiscal stimulus under Prime Minister Takaichi.
Conclusion: The traditional mean-reversion playbook for Japan appears increasingly outdated. A focus on GARP stocks with sustainable earnings growth and positive momentum looks more compelling—particularly in banking, industrials, and semiconductors. The outlook for rising earnings, margins, and valuations has improved, supported both by the new political configuration and the tangible progress of the TSE reforms.
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