Why Japanese Stocks Could Keep Rallying

Episode Summary

Executive Summary: Goldman Sachs’ Bruce Kirk argued that Takeichi’s election is highly consequential for Japan, likely supporting equities via greater political stability, foreign inflows, and hope for faster corporate governance reform. He sees further upside for Japanese stocks, but says the next phase depends on delivery—especially higher ROE, shareholder returns, restructuring, and policy clarity on fiscal and US-Japan issues.

Main Topics: Election-driven market re-rating (Priority: 5/5): Kirk says Takeichi’s snap-election victory is unusually important because a decisive mandate tends to lift Japanese equities, expand valuation multiples, and reduce political risk premiums. Political stability and policy continuity (Priority: 5/5): A stronger mandate may extend the prime minister’s tenure, improve policy continuity, and increase confidence among domestic and foreign investors. Fiscal policy concerns and market relief (Priority: 4/5): Investors had worried about a proposed consumption-tax cut, but the large victory may reduce the odds of more aggressive populist fiscal moves and ease bond/FX market concerns. Corporate governance reform and ROE (Priority: 5/5): The long-running reform agenda remains central; investors want faster progress on shareholder returns, restructuring, and especially higher index-level ROE to justify a sustained rerating. Foreign flows and global allocation shift (Priority: 4/5): Foreign investors are increasing exposure to Japan, helped by strong relative performance versus the US, but positioning is not yet stretched and could still rise. Risks to the rally (Priority: 4/5): Key risks include an unexpected resignation, policy missteps that unsettle bonds/FX, external growth shocks, and the usual volatility of Japanese equities.

Key Arguments: The election is highly consequential because a supermajority-style result historically correlates with strong post-election equity gains and valuation expansion. A larger mandate should increase political stability, lengthen expected tenure, and lower Japan’s equity risk premium. The market response reflects both expected policy shifts and improved investor perception of structural reform momentum. Fiscal fears were centered on a temporary food consumption-tax cut, but a bigger victory may actually reduce the chance of more extreme populist policy. Corporate governance reform has already boosted shareholder returns and valuations, but foreign investors still want more urgency and faster ROE improvement. The current rally is still in its upward phase, but the next stage requires real delivery from government, regulators, and corporates. Foreign investors remain underweight relative to historical peaks, suggesting room for further inflows rather than a crowded trade. Japan’s outperformance versus the US in dollar terms should attract additional global allocation. The biggest downside risk is political discontinuity, especially an unexpected resignation of the prime minister, which has historically marked market peaks. Sustained upside likely depends on higher ROE, stronger buybacks/dividends, growth investment, M&A-led consolidation, and restructuring.

Data Points: Japanese equities after prior major elections: ~20% average gain in the first 3 months - Historical reaction after previous LDP-led coalition supermajority elections (2005, 2012, 2014). Valuation multiple expansion after prior elections: ~3 points higher at peak, then settles at ~2-point premium - Observed pattern in the nine months following politically significant elections. Average tenure of a Japanese prime minister since World War II: ~1.5 years - Used to explain why a large electoral mandate can signal stability. Proposed consumption tax cut duration: 2 years - Takeichi pledged to lower the consumption tax on food temporarily before raising it again. Total shareholder returns before Abenomics: ~6-7 trillion yen per annum - Baseline for Japanese corporate payouts before the reform era. Total shareholder returns currently: ~40-45 trillion yen per annum - Shows the scale of improvement in shareholder returns after governance reform. Current market cycle start: Autumn 2022 - Kirk says the current Japanese equity market cycle began then. TOPIX performance since cycle start: More than doubled - Indicates the strength of the rally since autumn 2022. ROE level: ~9%-10% - Index-level ROE has largely flatlined despite the equity rerating. Foreign selling after 2024 BOJ sell-off: ~13 trillion yen - Foreigners sold Japanese equities, cash, and futures after the summer 2024 correction. Peak-to-trough TOPIX correction in summer 2024: 24% - The drawdown that scared many investors out of the market. Foreign buying before the election: 1.8 trillion yen net buying in one week - Weekly net foreign inflow reported the week before the election. Year-to-date foreign buying: 3.4 trillion yen - Net foreign buying through the latest data point cited in the interview. US dollar-based year-to-date performance: TOPIX +14%; S&P 500 flat; Nasdaq -2% - Japan is outperforming US markets in dollar terms, which may attract more flows. Market correction frequency: About 3 corrections >5% per year - Historical volatility pattern for Japanese equities.

Pivotal Quotes: "Our view is that this election result is extremely consequential, both from a political Stability point of view within Japan and as a positive for the overall Japanese equities market itself." — Bruce Kirk: On why Takeichi’s snap-election win matters for markets. "If we want to see Japan go through a sustainable valuation re-rating, then investors will want to see tangible improvements at that sort of index-level ROE." — Bruce Kirk: On what is needed for the next leg of the equity rally. "So I think the foreign positioning in Japan, it's improving, but it's still not at levels that you could call stretched." — Bruce Kirk: On whether global investors have already crowded into Japanese equities.

Implications: Japan may still have upside as political stability, reform expectations, and foreign inflows support valuations. But the rally now depends on execution: higher ROE, stronger shareholder returns, and careful fiscal policy, with political continuity a key risk to watch.