Prospects for Japanese Stocks Hinge on US Election

Japan’s stock market seems to have survived its recent snap election that raises questions about Japan’s future policies. Now it just needs to survive the US election, analysts say.

On Oct. 27, 2024, the ruling coalition led by the Liberal Democratic Party lost its majority in the lower house. New prime minister Shigeru Ishiba on Sept. 30 had called for a snap election to solidify his power base.

Japan’s stock market has been on a roller coaster this year. The benchmark Nikkei 225 stock average hit a high of 41,831 in July amid enthusiasm about Japan’s recovering economy, which finally produced inflation after decades. Corporate earnings had also advanced and the government instituted investor-friendly reforms. But in August, the Nikkei fell to its 2024 low of 34,501 following the rout in global stocks as well as the Bank of Japan’s move to raise interest rates. Stocks briefly recovered then sagged after the Liberal Democratic Party’s call for a snap election in September.

Ordinarily, uncertainty would put a cap on stocks. Yet, since the Liberal Democratic Party’s loss, Japan’s stock market has been reviving after a turbulent year. “The LDP loss leads to a weak coalition government making it difficult to push through partisan measures. So, this means we expect mainly status quo on the majority of policies in Japan,” says Lorraine Tan, Morningstar director of equity research, Asia.

There is plenty of opportunity. Right now, Japan trades at 14.4 times earnings, below its 10-year average of 15.0. “The continuity of market-friendly measures that Japan’s government has been making for the past decade and a half will continue in real terms,” says Shuntaro Takeuchi, who manages Matthews Japan MJFOX and Matthews Japan Active ETF JPAN.

Says Tan: “Japan shares are trading closer to fair value, but there remain pockets of buying opportunities. In addition, Japanese companies’ increased focus on capital allocation and improving shareholder returns is positive. We expect rising dividend payouts and share buybacks to support share prices.”

What’s Ahead for Japan?

Ishiba is an advocate of raising corporate taxes, partly to boost defense spending, and recently dropped plans to raise the capital gains tax. That market unfriendly posture is “why the market went down when he got elected” to the Liberal Democratic Party leadership and called the snap election, says Takeuchi.

One divisive LDP proposal was to reform Japan’s defense policy, which currently only allows a self-defense role. It would have allowed Japan to be more active in providing military assistance to allies and open up defense exports. “I believe that with the latest election outcome, any further moves to revise the constitution along these lines are stalled,” Tan says. “However, this also means that concerns that tax rates would rise to pay for the military’s modernization would also be off the table.”

To form a majority, the LDP will need to work with other parties. Two candidates are the Ishin no Kai, or the Japan Innovation Party, and the pro-reform Democratic Party for the People. “The LDP knows it will need to work with these two in order to get things done. The silver lining is [both parties] aim to goose consumer confidence and are more dovish with regards to fiscal policy,” says Takeuchi. For example, the DPP wants to increase the ceiling on tax-free annual income for part-time workers from JPY 1.03 million (USD 6,700) to JPY 1.78 million (USD 11.700). That would be a smart move, says Takeuchi. The DPP is supported by younger Japanese voters, who seek real wage growth after years of deflation.

Much Depends on the US Election

Globally, companies are concerned about US election uncertainty and have delayed spending. Takeuchi had scaled back his cyclical exposure on expectations that global recovery would take longer than expected. Putting the US election behind us would be a positive. At this point, Takeuchi says, “We would probably not reduce cyclicals further. We’re starting to warm up again on cyclical recovery.” Takeuchi’s largest positions include industrial automation company Keyence 6861, IT outfit Hitachi 6501, and Mitsubishi UFJ Financial 8306.

Morningstar’s Tan believes the yen, which weakened on the snap election, “is more likely to stay pressured.” But she notes that a weak yen “has been positive for exporters and the financial institutions. Our Japan banks analyst believes that the BOJ will continue to gradually raise interest rates allowing banks’ net interest margins to improve. While Japan bank shares have gained year to date, they’re not actually outperforming banks in our Asia coverage universe. So, we think there is still upside potential.”

Tan notes that Morningstar likes Sumitomo Mitsui Financial Group 8316 and Sumitomo Mitsui Trust Holdings 8309 best. Both currently have Morningstar Ratings of 4 stars.