Tokyo – Japan’s stock market is poised for continued growth, with Goldman Sachs forecasting a 10% return on the TOPIX index over the next 12 months. However, this potential rally is unfolding against a backdrop of political uncertainty as the nation prepares for a snap election on , and anticipated shifts in monetary policy from the Bank of Japan.
The election called by Prime Minister Sanae Takaichi is a “significant event,” according to Bruce Kirk, chief Japan equity strategist at Goldman Sachs Research. While the rationale for the snap election is understood, Kirk cautions that the strategy carries inherent risks. A victory for Takaichi’s Liberal Democratic Party and its coalition partner would likely bring greater policy stability, but also raises concerns among investors about potentially increased government spending and fiscal expansion.
Despite these concerns, Japanese equities have already demonstrated remarkable performance. Over the past three years, the TOPIX index has generated a cumulative total return exceeding 80%. Currently, equity market participants appear unconcerned about developments in the Japanese bond market, with both the TOPIX and Nikkei indices trading near record levels.
A key factor supporting the optimistic outlook for Japanese stocks is the anticipated normalization of monetary policy by the Bank of Japan. For years, Japan has operated with negative interest rates, limiting the BOJ’s ability to respond to economic downturns through conventional monetary easing. A move towards higher rates is seen as restoring this flexibility, providing a net positive for the equities market. Unlike many other economies where rising rates often correlate with declining equity prices, the situation in Japan is unique due to the prolonged period of negative rates.
Beyond domestic factors, the ongoing reindustrialization push in the United States is expected to benefit Japanese manufacturers. The US policy aims to bring high-end production back onshore, secure critical resources, and shorten supply chains. With China currently accounting for 28% of global manufacturing output – exceeding the combined share of the US, Japan, and South Korea – there is a growing expectation of increased cooperation between the US and its allies, including Japan and South Korea.
This shift is expected to create opportunities for Japanese companies in sectors such as infrastructure, shipbuilding, electronics, and critical minerals, benefiting both large and mid- and small-cap firms. Increased Japanese defense spending is anticipated to extend beyond companies with direct ties to the Ministry of Defense, encompassing areas like cybersecurity and supply chain security.
Japan’s strength in “physical AI” – encompassing industrial robotics, surgical robots, autonomous vehicles, and humanoid robots – is also highlighted as a potential growth driver. While Japanese firms have faced increasing competition from Chinese rivals in this sector, the changing geopolitical landscape and the US reindustrialization effort are expected to create new opportunities. Despite underperforming the TOPIX over the last three years, these companies are well-positioned to capitalize on emerging demand.
Goldman Sachs forecasts earnings per share growth of 8%, 9%, and 7% for fiscal years 2024, 2025, and 2026, respectively, assuming a yen/USD exchange rate of 150. This positive earnings outlook, coupled with the anticipated policy shifts and external economic factors, contributes to the overall bullish sentiment surrounding Japanese equities.
However, investors will need to navigate challenges related to US trade policy and the fiscal approach of Prime Minister Takaichi. The outcome of the election will be crucial in determining the direction of these policies and their impact on the Japanese economy and stock market.
Looking ahead ten years, Goldman Sachs forecasts annualized returns of 8.2% for Japan, placing it in the 79th percentile of its return distribution. The upside and downside returns are projected at 10.8% and 3.0%, respectively.
