Japan Equities: Inflation May Be Just What the Doctor Ordered

Japanese stocks have outperformed global equities by a wide margin this year. Is this a false dawn or can inflation continue to breathe life into the market?

Inflation and monetary policy tightening have been a major source of global equity market volatility over the past year. But in Japan, elevated and persistent inflation may be just what the doctor ordered to jolt companies and consumers out of a deeply entrenched deflationary mindset and unlock underappreciated opportunities for equity investors.

Deflation has subdued the Japanese economy and stock market for over three decades. Whenever Japan appeared to be on the verge of climbing out of deflation, nascent improvements were sidetracked by setbacks such as the global financial crisis, premature increases in the value-added tax and the COVID-19 pandemic. This time, however, the scale and durability of global inflation and its trickle-down effect on Japan, may be a game-changer, in our view.

The pickup in Japan’s inflation comes as efforts to improve corporate governance and profitability are starting to bear fruit. Demographic changes, geopolitical tensions, a shift in the global supply chain and a lack of strong upward pressure on the yen are also combining to create attractive opportunities across sectors, in our view.

Market performance reflects growing optimism. The TOPIX has surged 25.7% in yen terms in 2023 through September 30, compared with a 12.1% gain in the MSCI World Index in US-dollar terms. We believe inflation is just beginning to trigger changes across the Japanese economy that could support a sustained recovery for stocks.

With many Japanese equities still trading at a significant discount to their global counterparts—and many global institutions still underweight Japanese stocks—we believe a significant rerating of Japanese companies may be in store.