After Taking a Breather, Why Japan Stocks Could Keep Rising

Japan’s red-hot stock market is taking a pause, obstructed by the Iran war and the resulting surge in oil prices. Yet analysts and fund managers say there are reasons to believe the country’s stocks may be gearing up for new gains.

While Japan’s market looks fairly valued over the short term, its new government, ongoing corporate reforms, and renewed interest from foreign investors could buoy stocks. One caveat beyond the Iran war: Valuations are not as cheap as in years past.

Investors have been bullish on Japan since 2023, on the thesis that its long-sluggish economy was looking healthier, earnings growth was reasonable, valuations were cheap, and dividends and stock buybacks were on the rise. Over the past five years, the benchmark Tokyo Stock Price Index, or TOPIX, is up 99% in yen terms, while the Nikkei 225 is up 95%. Meanwhile, the Morningstar Japan Index is up 86% in yen terms and 42% in USD terms.

However, it has not been a straight-line rally. In August 2024, shares fell as the Bank of Japan hoisted interest rates, and the yen’s subsequent rise pummeled the carry trade (borrowing in the cheap yen to fund more expensive bets elsewhere), scaring foreign investors. The market revived, then seesawed through concerns about tariffs, monetary tightening, and elections. It hurtled higher in February after Prime Minister Sanae Takaichi’s Liberal Democratic Party won a supermajority in the House of Representatives.

Japan’s Vulnerability to the Iran War

The Iran war is problem for Japan, since liquefied natural gas supplies are being disrupted. LNG accounts for 36% of Japan’s electricity production, and the country imports nearly all of its fossil fuels. Since Feb. 27, TOPIX is down 4.2% and the Nikkei 225 is down 4.4%, slicing their respective year-to-date gains to 10.7% and 11.8%.

Higher oil and gas prices will raise input costs, boost inflation, and weigh on company operating margins. “It should not change the BoJ’s course in monetary policy, however, as that is based on inflation ex-fuel costs,” explains Morningstar strategist Lorraine Tan. Still, she thinks the war’s impact on company costs should be confined to the second quarter: “OPEC has already indicated that it will increase supply in April. We also don’t see the Iranian military being able to block the Strait of Hormuz for long, and lasting damage to Qatar’s LNG facilities is not in our base case.”

Japan Looks Fairly Valued Over the Short Term

Tan believes that despite recent losses, Japanese stocks are fairly valued after their strong year-to-date performance.

It’s a view echoed by Dan Hurley, international equity portfolio specialist at T. Rowe Price. “Valuations are a bit more stretched at 17.5 times forward earnings versus 14.0 times historically. The re-rating story has largely played out in terms of the multiple,” he says.

According to Yardeni Research, the forward profit margin for the MSCI Japan Index is about 9%, up from just over 1% 2009. While revenue growth is expected to fall by 2.0% in 2026 after advancing 5.8% in 2025, it’s expected to climb 4.4% in 2027 and 3.9% in 2028. Meanwhile, Yardeni expects earnings to rise 11.2% in 2026 and 10.3% in 2027 from an estimated 7.9% in 2025.

In the Long Term LDP Growth Plans Should Boost Stocks and Foreign Interest

Over the longer haul, observers say Japanese stocks look promising. Though the overall market is not as cheap it once was, it is still attractive compared with other major markets. The MSCI All-Country World Index fetches 19 times forward earnings, and the S&P 500 21 times.

Another cause for bullishness: The LDP’s supermajority makes it easier to deliver its pro-growth agenda. After the most recent election, Goldman Sachs Japan strategist Bruce Kirk upgraded his 12-month target for TOPIX to 4,300 from 3,900. (The index is currently at 3,772.) He told clients that Takaichi’s victory could “change global investor perceptions of the Japanese market. This should drive an acceleration in net foreign inflows and a period of index-level multiple expansion.”

Kirk says that after three previous elections in which an LDP-led coalition achieved a supermajority in the lower house, the market went up 20% on average in the following three months, followed by a multiple expansion of 2-3 points. He expects Takaichi’s policy agenda to grow clearer around defense, economic security, and the Japan-United States relationship. (Takaichi will visit US President Donald Trump for a summit on March 19.) Takaichi is also reportedly pushing for state investment in “national champions” in areas like artificial intelligence and chipmaking.

Stronger governance could buttress earnings growth. For years, corporate Japan was pressured by policymakers, regulators, activist shareholders, and proxy voting companies to improve returns. Japan’s Financial Service Agency is preparing rules to require firms to verify that they are using cash effectively, beginning this year. Listed companies hold some $840 billion in cash. In 2024, share buybacks increased 75% over 2023. Japan’s longstanding cross shareholdings are even being unwound. “Regulatory pressure ignited the wholesale selloff of cross shareholdings in the insurance sector, and even holdouts such as the Toyota Group companies have begun large-scale unwinding of cross shareholdings,” investment manager GMO writes.

A strengthening yen could also be a tailwind for foreign investors.

Investors Appear Underweight Japan

Meanwhile, many investors are underexposed to Japan. The average global large cap blend fund has 4.4% in the country, according to Morningstar data. At the same time, the iShares MSCI ACWI ETF ACWI, which is based on a widely followed benchmark, has 5.4% committed to Japan.

So far this year, around $30 million has come into Franklin FTSE Japan ETF FLJP, for a total of $500 million since the end of September, explains Dina Ting, head of global index portfolio management at Franklin Templeton. The ETF currently has $3.2 billion in assets. She says the case for global investors adding Japanese exposure is that “it’s good to invest in non-correlated assets, and correlation between US and international markets has been on the decline.”

According to Morningstar, Japan stock ETFs had year-to-date inflows of $691 million through Jan. 31, and $1.08 billion over the last 12 months.

Which Japanese Stocks Benefit?

T. Rowe Price likes parts of the market that may benefit from the government’s increased spending. Hurley thinks the domestic reflation story could bolster banks MUFJ MUFG and Resona 8308, as well as Mitsubishi Estate 8802.

In a February report, Goldman Sachs screened 430 listed Japanese companies to identify names exposed to eight corporate governance factors: share buyback momentum, an activist investor currently on the shareholder register, a large cross-shareholdings-to-net-assets ratio, a large number of operating segments, net cash and ROE below 8%, unrealized real estate gains of at least 5% of market capitalization, in the bottom 10% of 2025 AGM management approval rates, and calendar-year 2025 share price underperformance. Companies that met at least four of those criteria include Kyocera 6971, Dena 2432, Sumitomo Realty 8830, and Money Forward 3994.

Morningstar’s Tan thinks there are “pockets of opportunities,” and that selling is overdone on concerns over AI’s impact on software and gaming names is probably overdone.

Among the stocks that Tan highlights:

Kirin 2503

“We think Kirin has potential to grow its revenue and profit in Japan and overseas by creating synergies between FANCL, Blackmores, and its deep-rooted distribution network from the beer business. There are opportunities for the company’s health supplements to expand, leveraging its pharmaceutical capabilities. The domestic alcoholic beverage business may be a point of concern for some investors, but we think Kirin is strengthening its beer brands to gradually offset the declines in happoshu and new genres.

“As a result, we no longer believe Kirin would be disadvantaged vs. Asahi in Japan, despite a larger composition of low-malt/no-malt alcoholic products, as well as the incoming unification of beer tax in late-2026. Finally, management has prioritized improved capital allocation by increasing shareholder returns (including share buybacks) and selling off non-core businesses. We think these initiatives could help improve market sentiment on the stock.”

Nintendo 7974

“We believe Nintendo’s shares are undervalued because the market is focusing too much on short-term challenges and underestimating the long-term growth potential of the firm’s game and console shipments, which leverage its attractive characters.”

Keyence 6861

“The market appears overly focused on the recent moderation in headline growth, overlooking that management deliberately slowed hiring to prioritize per-employee efficiency. We believe this efficiency-first approach is strategically sound, particularly given that overseas sales per employee still trail domestic levels by a wide margin. As highlighted in the company’s latest presentation, the overseas total addressable market is several times larger than its current revenue base, implying meaningful long-term runway once overseas hiring and capacity expansion reaccelerate. This gap underscores why current growth should be viewed as a pause for optimization, not a structural slowdown.

“Importantly, Keyence’s unique direct-sales model, rapid product development cycle, and solution-based value proposition remain firmly intact. These fundamentals continue to underpin its exceptionally high margins and strong cash generation. With operational discipline maintained and overseas expansion poised to resume, we see scope for both continuous topline growth and a market re-rating over the medium to long term.”