If your portfolio looks like most Western retail investors’ portfolios, it is heavily allocated to US equities, probably through an index fund that gives you roughly 65% exposure to American companies. That allocation has served you well for the past decade. The question is whether it will continue to do so, and whether you are missing something by not looking elsewhere.

Goldman Sachs, JPMorgan, BlackRock, Janus Henderson, Invesco, and Daiwa Asset Management have all published constructive outlooks on Japanese equities for 2026. These are not speculative calls from boutique firms. These are the largest asset managers and investment banks in the world, and they are allocating real capital.

According to JPX investor-type data, net foreign purchases of Japanese cash equities reached roughly ¥5.4 trillion in 2025. The buying accelerated in the fourth quarter after Takaichi’s election as LDP president and her subsequent landslide. That is institutional money moving at scale.

Here is what appears to be driving it.

Japan has broken out of deflation

The break from deflation is the single most important development, and it is one that many Western investors have not fully internalised. Japan spent three decades in deflation. Prices were flat or falling. Wages stagnated. Companies hoarded cash rather than investing. Equities were dead money for an entire generation.

That era appears to be over. Headline consumer prices have remained above the Bank of Japan’s 2% target since April 2022 – more than three and a half years of sustained inflation, the longest such period in over thirty years. Wage negotiations in 2025 delivered increases exceeding 5% at large companies (Rengo Shunto results), and real wage growth has turned positive. JPMorgan has noted this as the most significant shift in Japan’s macroeconomic regime in a generation.

For equity investors, the transition from deflation to moderate inflation is transformative. It means nominal revenues grow, companies regain pricing power, and the discount rates applied to future earnings become more favourable. Japan is repricing from a deflationary market to an inflationary one, and that repricing may still have a long way to run.

Companies are returning capital to shareholders

If you have ever dismissed Japanese companies as complacent cash hoarders with no regard for shareholder value, it is worth updating that view.

In March 2023, the Tokyo Stock Exchange asked companies trading below a price-to-book ratio of 1.0 to disclose concrete plans for improvement. The TSE then published monthly lists naming which companies had responded and which had not. The reputational pressure proved remarkably effective.

Share buybacks reached approximately ¥18 trillion in FY2024, roughly double the pre-pandemic level. Dividends have increased for five consecutive years. Cross-shareholdings, a longstanding drag on capital efficiency, are being unwound. According to Nomura, they declined to 30.8% of TSE market capitalisation at the end of March 2024, down from approximately 60% in 1990. The proceeds from unwinding are flowing into buybacks and dividends, creating a virtuous cycle.

Janus Henderson notes that Japan’s total shareholder return ratio reached parity with European companies in FY2024, at roughly 60%. The gap with US companies remains, but the direction of travel is clear and accelerating.

For investors accustomed to the capital discipline of US blue chips, Japanese companies are beginning to speak a language you understand.

The valuation gap

Despite all of this improvement, Japanese equities trade at a meaningful discount to US equities on a forward price-to-earnings basis. Some of this discount is justified by the premium that US technology companies command. But some of it reflects institutional neglect. Many global allocators reduced their Japan weightings during the lost decades and have been slow to rebuild.

The TOPIX rose approximately 38% in the twelve months through early 2026. Unlike the US market, where returns are driven by a narrow group of mega-cap technology stocks, the Japanese rally has been broad-based. Banks are benefiting from rate normalisation, industrials from fiscal spending, and consumer companies from wage growth and pricing power. This breadth suggests the rally has structural support rather than being driven by a single theme.

If you are an investor who is uncomfortable with the concentration risk in US index funds, where a handful of companies account for a disproportionate share of returns, Japan offers something different: diversified exposure to genuine fundamental improvement at valuations that do not require everything to go right.

Political stability and a growth agenda

Western investors sometimes worry about political risk in Japan. The current environment is unusually stable. Prime Minister Takaichi won a landslide in the February 2026 snap election, giving her coalition a two-thirds parliamentary supermajority. The policy framework is explicitly growth-oriented: the largest budget in Japanese history at 122.3 trillion yen, strategic investment across 17 priority sectors including semiconductors and AI, and a defence buildup targeting 2% of GDP.

For institutional allocators who weight political stability heavily in their country allocation decisions, Japan currently ranks well. A government with a strong mandate and a clear economic programme reduces uncertainty, and uncertainty is what international investors like least.

The currency opportunity

There is one more dimension that is easy to overlook but potentially significant. The yen is near multi-decade lows against the dollar and the euro. If the structural forces now favour yen appreciation – as discussed in more detail in our analysis of the new Fed chair – investors who buy Japanese equities today could benefit from both the equity return and a currency tailwind as the yen recovers.

The contrast with US equities is direct: a weakening dollar would not provide any additional return for dollar-based investors. For those looking to diversify currency exposure away from the dollar, yen-denominated assets offer a natural complement.

What could hold this back

The bullish case is not without risks. Previous waves of Japan optimism have disappointed, and investors should weigh several factors.

Yen appreciation, while a tailwind for foreign holders, can compress earnings for export-heavy companies. If the BOJ tightens faster than expected, the adjustment could be disorderly. The governance reform push, while real, still relies heavily on financial engineering – buybacks and dividend increases – rather than operational improvement at many companies. And Japan’s demographic trajectory, with a population declining by roughly 800,000 per year, places a structural ceiling on domestic demand growth that no fiscal programme can fully offset.

The question is whether the current set of tailwinds – governance reform, political stability, rate normalisation and institutional re-allocation – is strong enough to outweigh these headwinds over a multi-year period. The major asset managers appear to think so. Whether retail investors follow is a separate question.

— Gyokuro · Disclaimer · Support