Will Japanese Stocks Rally to Fresh Record Highs?

Over the last three years, Japan’s TOPIX index has generated a cumulative total return of more than 80%. Bruce Kirk, Goldman Sachs Research’s chief Japan equity strategist, says it’s getting more challenging for the country’s stocks to generate those kinds of gains.

Kirk forecasts the index will return 10% in the next 12 months (as of January 30). But investors in the Japanese equity market must navigate the challenges of US trade policy as well as the fiscal approach of Sanae Takaichi, Japan’s prime minister. She has already shaken things up by calling a snap election on February 8. 

“The election is going to be a significant event,” Kirk says. “I can understand why the prime minister is going to the ballot box now but the strategy is not without risks.” 

We spoke with Kirk about those risks, as well as five key investment themes he says are poised to bolster the stock market. They range from Japan’s strength in “physical AI” to why higher rates are positive for Japanese equities. 

What’s at stake for investors in the election on February 8?

If Takaichi’s Liberal Democratic Party and its coalition partner can get a working majority, the government will gain more policy stability. The flipside is that investors are worried that having a stronger policy mandate means she will spend more aggressively and fund a fiscal expansion. 

That is a trend that bond investors are focused on at the moment. But if you look at equities markets, both the TOPIX and the Nikkei are close to record levels. Equities market participants do not seem to be concerned about what is happening in the Japanese bond market. 

The Bank of Japan (BOJ) is expected to hike rates this year and in 2027. Why would higher rates buoy the stock market?

In other economies, investors focus on the negative correlation between rising rates and lower equity prices because this is usually associated with slowing down an overheated economy or lowering inflation. The story is different in Japan. 

For a number of years, we have had negative interest rates in Japan, well below zero. So, the BOJ couldn’t use monetary policy levers to deal with a sudden falloff in demand by cutting rates. Now we see the BOJ trying to get back to a normalized level, and this way if we do see a recession, the bank can respond with normal policy tools. Getting back this flexibility is a net positive for the equities market.

Another significant theme is the US’s reindustrialization push. How will this benefit Japanese manufacturers and their shareholders?

It’s clear the underlying message in US trade policy is the desire to bring high-end production capacity back onshore, secure access to critical resources, and shorten supply lines. China now accounts for 28% of total global manufacturing output, which is greater than the US, Japan, and South Korea combined. 

As concerns mount about China’s dominance in critical supply chains and industrial sectors, there is likely to be greater US cooperation with allies such as Japan and South Korea. This leaves the field clear for Japanese companies involved in infrastructure, shipbuilding, electronics, and critical minerals. This should benefit mid- and small-cap firms as well as large caps. 

At the same time, there is an understanding among policymakers that Japan needs to boost its defense spending. We are looking at how spending is shifting from Japanese companies with a direct relationship with the Ministry of Defense to the broader theme of cyber security and supply chain security. 

Will this trend also bolster Japan’s “physical AI” sector?

Yes, a reindustrialization push could further create meaningful opportunities for Japanese firms in sub-sectors such as industrial robotics and factory automation. Physical AI covers more than industrial robotics—it also encompasses surgical robots, autonomous vehicles, and even humanoid or general-purpose robots. 

Even though Japanese physical AI concerns dominate the space, many of these companies have underperformed the TOPIX over the last three years because they have lost market share to Chinese rivals. Again, we believe Japan will be better placed to benefit from new US-based physical AI opportunities. 

While the TOPIX has performed well recently, it significantly lags the return on equity levels of other global indexes. Why is this important?

There are two issues: Net profit margins could be higher, and balance sheets are too large. Japanese management has long felt comfortable with holding as much cash as possible. Part of the reason stems from Japan being in an earthquake zone and so the tail risks, the chances of a rare and extreme event, loom large. The bursting of the bubble back in 1989 also encouraged corporate leaders to take a very cautious approach to balance sheet management. As a result, Japanese companies generally do not return as much value to their shareholders as their counterparts in other markets.

Is this trend about to change?

In terms of corporate governance, there is significant action on the horizon. Since 2023, we have seen the Tokyo Stock Exchange, or TSE, make moves to improve shareholder returns. We also see a top-down alignment between the TSE, the Financial Services Agency, and the Ministry of Economy, Trade, and Industry on this issue. If you look at their recent policy announcements, you can see they are trying to make the market fairer for minority shareholders with a new corporate code of conduct, which came into effect last July, and other measures.

One of the criticisms foreign investors have of Japan is that when it comes to takeover bids, sometimes the conditions are pushed through to the detriment of minority shareholders. There is a feeling that the takeover price is a lot lower than the true value of the company. So, boards are now supposed to issue a statement on whether the terms are fair and provide more clarity on how the takeover price was calculated.

An improvement in shareholder rights should translate into accelerated shareholder returns and spur more dealmaking and restructuring, which is also good for investors. 

The stocks of Japanese exporters have been outperforming domestic stocks since the US announced global tariffs last April. Is this changing?

We do think investor focus is likely to shift toward domestic stocks. We are starting to see sticky inflation accompanied by quite solid wage growth. That is something new in Japan, where we have seen decades of deflation. Whenever companies tried to raise prices, demand fell off a cliff, and there was no increase in disposable income. 

Now we have real top-down pressure from the government to raise wages. We have a virtuous cycle in place that could benefit domestic demand-related stocks. 

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