Investment Strategy
Why Japan remains one of our top calls
Our 2025 Outlook remains positive on risk assets, with U.S. equities remaining one of our top conviction ideas. Outside of the United States, Japan stands out as our favorite market given its relative macro stability and safety amid global trade uncertainty. 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% annualized returns, we continue to maintain our multi-year positive thesis on the market.
In this Asia Strategy Focus, we assess Japan’s position as tariff risks ramp up, look at the current state of the country’s economy and monetary policy, and deep dive into opportunities within its equity markets.
What we think
The U.S.-Japan trade relationship appears on track and Japan could escape being singled out for tariffs, but that does not make it fully immune to rising global trade uncertainty – as spillover effects can still have a negative impact. Despite a more complex global backdrop, we expect Japan’s economy to hold steady in 2025. Domestically, our base case for mild reflation continues to play out with stable inflation and wage growth. Overall economic conditions do not suggest that the Bank of Japan needs to rush on rate hikes.
Investment implications
We retain a constructive view towards Japanese equities, with low-teens upside to our YE25 outlook. On a multi-year basis, our positive thesis on Japanese equities is mainly driven by 1) mild inflation after decades of deflation; 2) improvements in corporate governance; and 3) international and domestic investors remain under-invested in Japanese equities. We are increasingly comfortable investing in Japanese equities without an FX hedge.
Is Japan a safe haven amid tariff risks?
When thinking about Japan’s outlook, it is impossible to ignore the broad sense of uncertainty around U.S. trade and foreign policy. During President Trump’s first term, Japan stood out as an island of stability amid tumultuous U.S. foreign relations. However, under today’s new Japanese leadership there are questions as to how Trump will view the U.S.-Japan alliance and how much pressure he could exert on Japan over its bilateral trade surplus. Personal relations between Trump and the late Japanese leader Abe were famously warm, which kept the alliance stable and broadly free from trade tensions. However, under Prime Minister Ishiba there are new questions as to how Trump will approach the relationship, particularly around trade. These risks cannot be taken lightly – Trump is focused on reciprocity and Japan runs a large bilateral trade surplus with the U.S., even as the absolute size has moderately declined over the past two decades, and is relatively small compared to the China and Europe deficit. The U.S. trade relationship is also important for Japan – exports make up over 20% percent of GDP and exports to the U.S. make up 20% of total exports.
THE U.S. TRADE DEFICIT WITH JAPAN HAS NOT GROWN COMPARED TO OTHER COUNTRIES SUCH AS CHINA, EUROPE AND MEXICO
U.S. trade deficit and partner countries, USD billions
Source: J.P. Morgan Investment Bank. Data as of February 5, 2025.
Thankfully, the recent U.S.-Japan meeting helped to quell some concerns. Trump did push Ishiba on the trade surplus, but quickly dismissed it as a problem that can be solved with increased Japanese purchases of U.S. oil and gas. The unresolved issue around Nippon Steel’s attempted acquisition of U.S. Steel also potentially found an off-ramp – and the acquisition attempt may be dropped with Nippon instead making a large investment. Japan remains the largest source of foreign direct investment (FDI) into the U.S. and Trump has made clear that his goal is to increase this further.
JAPAN IS THE LARGEST FDI INVESTOR IN THE U.S. OVER THE LAST DECADE
FDI in the U.S. by major countries, USD billions
Source: J.P. Morgan Investment Bank. Data as of February 5, 2025.
For now the relationship appears largely on track and Japan could escape being singled out for tariffs, but that does not make Japan fully immune to the rising global trade uncertainty. Spillover effects from global trade threats can still have a negative impact. One way to look at this is through data that tracks trade policy uncertainty. This measures the frequency of tariffs and trade policy mentions in the media, and this data tends to have a fairly close correlation with measures of economic activity in trade-dependent economies. For Japan and Europe, broadly rising trade uncertainty can depress business investment and manufacturing activity. Although Japan has so far not been directly targeted by bilateral tariffs, it could very well be part of any universal tariff plans (unless exemptions are granted).
HIGHER TRADE UNCERTAINTY FORESHADOWS HIGHER TARIFFS
Source: Haver Analytics; Baker, Bloom & Davis; Bloomberg Finance L.P. Data as of January 31, 2025.
Prime Minister Ishiba left Washington with a newfound confidence he can continue Abe’s legacy of managing relations with the U.S., but if the Trump administration continues to ramp up global tariff rhetoric it could still come back to bite Japan. A material weakening of global (ex-U.S.) growth could still have negative knock-on effects for Japan’s capex and labor markets.
Can Japan’s virtuous cycle continue?
Despite a more complex global backdrop, we expect Japan’s economy to hold steady in 2025.
Domestically, our base case for mild reflation continues to play out. Services inflation – a good gauge of core inflation pressures, has stabilized on trend, supporting the virtuous wage cycle (nominal wage growth has averaged 2.8% in 2H 2024). Although headline wage growth jumped to a three decade high of 4.8% in December 2024, it may be a result of idiosyncratic factors, as same-sample wage growth was maintained at 2.8%. As inflation has stabilized, real wage growth turned positive for the second month in a row in December 2024, making the backdrop more positive for consumers. That said, overall consumption growth has remained underwhelming, suggesting that it takes time for consumers to regain their economic confidence.
REAL CONSUMPTION IN JAPAN HAS CONTINUED TO LAG DUE TO INFLATION
Japan consumption, adjusted for tourism, indexed 2015 = 100
Source: Bank of Japan, Haver Analytics. Data as of December 31, 2024.
In our view, Japanese consumption needs two factors in order to improve. First, continued strong wage growth is required. In other words, the ongoing virtuous wage and inflation dynamic needs to be maintained. The upcoming Shunto wage negotiations are important – it is likely that the unions may secure another year of ~5% wage growth. Secondly, and more importantly, a productivity breakthrough is likely needed. In the context of declining demographics and the growth of AI, Japanese corporate capex has been accelerating over the past few years. If the investments are effective, it could boost productivity growth and help Japan break through the ceiling of 0.5% real GDP growth. The relatively high level of corporate optimism suggests Japan is still on track with its growth and reflation plan, but rising global economic policy uncertainty presents risks to this view.
JAPAN’S CAPEX SPENDING HAS BEEN ACCELERATING OVER THE PAST FEW YEARS
Japan’s capital expenditure, 4-quarter moving average, YoY %
Source: Tankan (Short-Term Economic Survey of Enterprises in Japan), Bank of Japan, Haver Analytics. Data as of December 31, 2024.
No rush for the Bank of Japan
What all of these factors boil down to for the Bank of Japan (BoJ) is still a policy of gradual normalization. After a well-flagged 25bps hike, the BoJ has given mixed guidance. Strong wage growth in December has led Naoki Tamura – a known hawk on the BoJ board – to push for two more hikes in 2025, bringing the policy rate to 1% (a sort of lower bound of the estimated neutral range). We think it’s still too early to lock in another rate hike, let alone two for the rest of the year, as overall economic conditions do not suggest a need to rush. That said, if global economic conditions materially improve – either led by the U.S., China or Europe – a faster pace of rate hikes could be warranted.
Lastly, political factors could push for faster rate hikes. Domestically, many politicians have pushed for this in order to correct JPY weakness, especially before the first rate hike in July 2024. Investors are also contemplating the risk that the new U.S. administration may exert pressure for a JPY appreciation. Indeed, Treasury Secretary Bessent has expressed the view that such developments could be positive for Japan, which seems to support President Trump’s view on the need for a weaker USD (and stronger JPY) as well. While these are just perspectives, not policy, there is a risk that external pressure somewhat dovetails with domestic political considerations, and leads to a more broad-based push for faster rate hikes, though this is not our base case.
Tourism continues to boom
Japanese tourism is booming. Many recent (often first-time) visitors to Japan have complained about crowding and over-tourism. But on the plus side, the tourism sector has brought a welcome boost to the economy, with a sharp recovery in visitor numbers back above 2019 levels to reach a record 36.87 million. Foreign tourists spent a record 8.14 trillion yen ($51.78 billion), with the sector’s broader contributions to the economy estimated at 44.6 trillion yen, accounting for 7.5% of Japan’s GDP. This has supported employment in the sector (surpassing 6 million jobs) and provided tailwinds to areas such as consumption and specific segments of real estate.
Further on real estate, a sustained, relatively accommodative monetary policy environment, plus factors supporting return-to-office, low vacancy rates and corporate divestments of noncore real estate holdings are providing strong fundamentals to the office sector, which can be capitalized on by experienced real estate managers.
Reiterating our positive view on Japanese equities
We retain a constructive view towards Japanese equities, with low-teens upside and a YE25 outlook of 3,075 – 3,175. This is based upon an expectation of 2025/2026 earnings growth of 9.0% and 8.5%, and a forward P/E multiple of 15x. FY3Q25 earnings have just begun: with ~60% of companies having reported, earnings for the quarter are expected to grow by 20%, up from 7% at the start of the earnings season. Our preferred sectors include Financials, Industrials, and Consumer Discretionary. On tariff risks, we estimated that exports to the U.S. represent ~15% of sales, with the corresponding earnings impact from a potential 10% tariff at around -2% for the TOPIX.
WE RETAIN A CONSTRUCTIVE VIEW ON JAPANESE EQUITIES
TOPIX index expected return breakdown
Source: Bloomberg Finance L.P., J.P. Morgan Private Bank. Data as of January 27, 2025.
*Note we have used JPM PB NTM P/E 2024.
*Note we have used JPM PB NTM P/E 2024.
From a cyclical perspective, global manufacturing PMI’s have been tepid since late 2022. But there are signs of some recovery, with levels back above 50. Historically, this has been constructive for accelerating earnings growth for the TOPIX. Clarity after the U.S. election results could also release pent-up U.S. capex demand and benefit capital goods companies in Japan.
SIGNS OF RECOVERY IN GLOBAL MANUFACTURING ACTIVITY SIGNALS A POSITIVE OUTLOOK FOR TOPIX EARNINGS
Source: J.P. Morgan Investment Bank, Bloomberg Finance L.P.. Data as of January 2025.
On a multi-year basis, our positive thesis on Japanese equities is mainly driven by:
- Return of inflation after decades of deflation. Japan is entering its fourth year of inflation above 2%, the longest such period in over three decades, and it is looking increasingly sustainable. Mid-single-digit wage growth remains on-track, driving a recovery in real purchasing power, alongside a pick-up in Japanese capital expenditure. These factors are self-reinforcing and provide a tailwind for the Japanese economy and corporate earnings.
JAPAN ENTERS FOURTH YEAR OF INFLATION ABOVE 2%
Japan nationwide CPI, YoY %
Source: J.P. Morgan Private Bank, Bloomberg Finance L.P.. Data as of January 2025.
- Meaningful improvements in corporate governance. Catalyzed by the Tokyo Stock Exchange’s decision to list companies that pay attention to their cost of capital and share price, we have witnessed a meaningful change in Japanese management behavior in the past 12-18 months. Japanese corporates have long been criticized for hoarding cash on their balance sheets and long-standing, capital-inefficient cross shareholdings. Over the past 12 months, share buybacks are on track to increase 96% YoY, and the reduction in cross-shareholdings has increased by 75% in the last fiscal year.
JAPANESE SHARE BUYBACKS ARE TRACKING UP 96% YOY
Corporate share buyback notional, trillions of yen
Source: J.P. Morgan Private Bank, Bloomberg Finance L.P.. Data as of January 2025.
- International and domestic investors remain under-invested in Japanese equities. While the TOPIX generated 20% in total return in 2024, foreign investors did not really participate in the rally, and were overall net sellers of Japanese equities. Given the positive factors highlighted above, there remains significant scope for international investors and domestic individuals to increase exposure to Japanese equities. In fact, the single largest buyer of Japanese equities since 2024 are Japanese corporates via share buybacks. There remains meaningful scope for positive inflows into the asset class, which could provide a potential tailwind.
JAPANESE EQUITIES REMAIN UNDER-OWNED BY DOMESTIC RETAIL INVESTORS
Retail asset allocation to cash and equities, %
Source: J.P. Morgan Asset Management, Bank of Japan. Data as of December 2023.
There are also a number of factors that are supportive to the structural investment opportunity in Japanese equities.
- Earnings have historically outperformed the economy. A relatively slower growing Japanese economy has not hampered equity returns. Over the medium and long-term, earnings drive share prices and equity indices. Earnings-per-share growth has been a clear driver of long-term U.S. equity outperformance. What is less discussed is that Japanese corporate earnings have largely matched that of the U.S. since 2010, even though Japan’s GDP only grew modestly. This highlights that Japanese-listed corporates are exposed to global growth opportunities and over time have grown earnings at an impressive rate, even amidst a slow-growing domestic economy. With the TOPIX trading at a price-to-earnings of 30% lower than the S&P 500, we continue to see attractive value.
JAPAN’S CORPORATE EARNINGS HAVE LARGELY MATCHED THAT OF THE U.S. DESPITE MODEST GDP GROWTH
TOPIX EPS, S&P 500 EPS, MSCI Europe EPS, Japan Nominal GDP CY2010-CY2024 estimated, indexed 2020 = 100
Source: J.P. Morgan Asset Management. Data as of October 2024.
- Return on equity progression. In addition to companies becoming more aggressive in returning cash to shareholders, Japanese corporates are also increasingly focused on profitability. Specific actions to reduce or sell loss-making businesses, improve operating efficiency, and increased competitiveness due to a weaker currency have all likely contributed to expanding margins and improving return on equity. While we expect margins and returns on capital to reach some of the highest levels since the global financial crisis in 2025, these metrics remain weak compared to developed market peers and we expect this to further improve over time.
JAPANESE CORPORATES’ RETURN ON EQUITY HAS RISEN DUE TO IMPROVED PROFITABILITY AND OPERATING EFFICIENCY
Return on Equity (ROE), YoY %
Source: J.P. Morgan Private Bank, Bloomberg Finance L.P.. Data as of January 2025.
Japanese yen – to hedge or not to hedge?
The JPY has emerged as a top performer among major currencies year-to-date. While positive developments in wage growth and hawkish signals from the BoJ have provided support, our analysis indicates that the majority of the movement in USDJPY can still be attributed to the recent decline in U.S. interest rates. This suggests that the strong correlation between USDJPY and U.S. Treasury yields observed in this cycle remains intact. Consequently, 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, which is not our base case.
RECENT MOVES CAN BE LARGELY ATTRIBUTED TO THE DECLINE IN U.S. YIELDS
USDJPY vs model implied level
Source: J.P. Morgan Private Bank, Bloomberg Finance L.P. Data as of February 11, 2025.
As such, our neutral view on USDJPY remains unchanged. While we acknowledge the positive economic developments in Japan, the strength of the USD and the prospect of sustained elevated U.S. interest rates may limit the downside potential for USDJPY. As an export-oriented economy, Japan may still encounter growth challenges due to potential trade disruptions within Asian value chains, with the uncertainty possibly keeping the BoJ on the sidelines until the second half of the year.
That said, in light of escalating geopolitical risks, defensive low-yielding currencies such as the JPY and CHF can be strategically positioned as long positions on crosses (against EUR, CNH) or as a means of portfolio diversification. We are increasingly comfortable with investing in Japanese equities without an FX hedge, thereby maintaining a natural hedge against weaker global risk sentiment.
All market and economic data as of February 13, 2025 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.
Indices are not investment products and may not be considered for investment.
Past performance is not a guarantee of future results. It is not possible to invest directly in an index.
The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.
RISK CONSIDERATIONS
- Past performance is not indicative of future results. You may not invest directly in an index.
- The prices and rates of return are indicative as they may vary over time based on market conditions.
- Additional risk considerations exist for all strategies.
- The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
- Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
Index definitions:
The TOPIX, also known as the Tokyo Stock Price Index, is a capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange. The index is supplemented by the subindices of the 33 industry sectors.
The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.
The MSCI Europe index is an equity index which tracks the performance of large and mid-cap equities across 15 developed countries in Europe.
The Bank of Japan (BOJ) releases data on the Consumption Activity Index (CAI) on a monthly basis. Real Consumption Index measures consumer spending using constant prices, adjusting for inflation.
Nominal Consumption Index measures consumer spending in current prices, without adjusting for inflation.
The Global Purchasing Managers' Index (PMI) is a key metric in assessing a country's economic health. It looks at the manufacturing sector, by surveying output and employment intentions of manufacturers. A level above 50 indicates economic expansion, while a number below 50 indicates a contracting economy.
Japan currently stands out as our favorite market given its relative macro stability, safety amid global trade uncertainty.
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