Japan doesn’t often lead the financial headlines, despite being one of the largest equity markets in the world. Yet its political changes have got financial markets excited, with rises in the yen and in long-dated government bonds. Could the drama around the country’s snap election spill over into stock markets?
Prime Minister Sanae Takaichi came into office in October and announced a snap election on 19 January. Her victory is seen by some as an endorsement of her economic plans. She styles herself as a supporter of former Prime Minister Shinzo Abe, whose expansionist spending policies revived the Japanese economy in the 2010s.
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Can Japan afford more spending?
The problem is that Japan already spends quite a lot. At 233%, its debt to GDP is vastly higher than other developed economies*. The prevailing view is that the Japanese central bank has been slow to raise rates. Any additional spending could combine with too-low interest rates to create a potent inflationary mix that could drive government borrowing costs higher. Longer-dated Japanese bond yields have already come under pressure.
This, in turn, has created pressure on the yen. At the end of January, the Japanese currency saw a rapid rise against the dollar that even spooked US policymakers. It has subsequently dipped again, but it showed the fragility of current market pricing.
For the time being, stock markets have stood apart from the turmoil in bond and currencies markets. The Nikkei is up 7.4% since the start of the year** and 30% over one year***. In 2025, Japanese funds outpaced the North American sector, with the average fund up 17.4% in sterling terms***. It was also a better year for smaller companies, with the MSCI Japan Small Cap index up 19.8% over 2025 (compared with 16% for the MSCI Japan)***.
Why investors still like Japan
There are also lots of reasons still to like Japanese markets. Carl Vine, manager of the M&G Japan fund, says the corporate governance improvement that has driven Japanese companies over the past few years still has further to run. He believes that Japanese companies could be in line to grow their earnings significantly, which should, in turn, drive share prices. He points out that Japanese companies have delivered approximately the same earnings growth as S&P 500 companies, but without the favourable economic backdrop.
Nevertheless, investors cannot entirely ignore the movements in the yen and Japanese government bonds. After all, if the yen is appreciating it will pump up their gains, but some companies could suffer – notably the country’s strong export sector, which could see their products become less competitive.
Carl tries to ensure that he does not take bets on the currency, keeping his exposure approximately in line with the benchmark. He wants the majority of the portfolio’s risk to come from stock selection rather than macroeconomic factors. That means if he wants to buy a heavy exporter, he will sell down other yen-exposed areas.
He says that the impact of currency movements may not be as impactful as many believe. While around 50% of the index is in exporters, and therefore nominally exposed to yen weakness, many companies hedge their exposure. “It’s not as high as people think,” he says.
“I think what matters more for Japanese equities is global growth than actually what the yen does. In fact, you saw the reverse of that in 2022. At the beginning of the year, the yen was 114, by October, it touched 150. The reflex might be that during that period, the exporters all outperformed. They didn’t, because people were worried about global growth. That’s why we try to insulate the portfolio from it.”
A strategic role in global portfolios
Global managers are finding selective opportunities in Japan, particularly those with a value tilt to their portfolios. Sean Peche at Ranmore Global Equity, for example, holds Miura, a Japan-listed golf club manufacturer^. T. Rowe Price Global Focused Growth Equity and Fidelity Global Dividend hold 5.6% and 5.7%, respectively, in Japan^.
Japan leads in certain areas, such as robotics, and it is difficult to replicate the same exposure elsewhere. With this in mind, Japan may play a role in diversified global portfolios.
Japan has shown itself to be good at keeping its head below the parapet on some of the geopolitical tensions and it remains an interesting area in which to invest. Politics may create short-term wobbles, but long-term investors may look through short-term political volatility.
