Why some investors are turning to Japan

Japan is emerging as a destination for investors seeking opportunity amid a slowing global economy.

The world’s third-largest economy has managed to emerge from deflation without runaway inflation, and capital expenditure from the private sector is rising. But perhaps most significantly, Japan’s nominal gross domestic product (GDP), which measures output at current prices, is rebounding.

“This marks a momentous change for Japan after economic growth has languished in negligible or negative ranges for years,” says Morgan Stanley’s Chief Japan Economist Takeshi Yamaguchi.

Meanwhile, the government and businesses are working together to secure political security, supply-chain security, and economic prosperity through faster technology adoption; a more flexible, mobile, and skill-based labor market; better governance; and fiscal sustainability.

Japan's shift to solid nominal growth is important for equity market returns. Here’s some information that investors need to know.

Nominal GDP growth, which covers price changes for the entire economy and is the sum of real GDP growth, is forecast to reach +3.7% in 2025, up from +2.9% in 2024.

This real growth may be accompanied by moderate domestic inflation and an improvement in the difference between export prices and import prices. In 2024, Japan's nominal GDP growth reached 4.1%, compared to an average of 3.2% in 2021-23 and well above the 0.2% from 1995-2021.

This higher growth trend in Japan also implies growth for employee compensation and corporate earnings, a large increase in tax revenue, and potentially positive effects on asset prices, says Yamaguchi.

“In the era of higher nominal GDP, we expect Japanese stocks to outperform, driven by five factors,” says Japan Equity Strategist Sho Nakazawa.

1. Faster revenue growth: Sales for companies focused on the domestic market should see some acceleration alongside nominal GDP as they increase prices and/or sales volume.
2. Improved profit margins: Operating profit margins should benefit as companies can adjust their product mix more easily and pass through increases in input costs to final prices. Increased sales should offset companies’ fixed costs, even for those sectors with limited pricing power, such as department stores and food and beverage.
3. Central bank normalization: With the return to inflation, the Bank of Japan raised rates in 2024.
4. Investor shift to equities: Japan's households are generally conservative in their investment portfolios, partly as a result of the longstanding deflation. The combination of the “inflation tax” higher nominal returns on equities, and easier tax treatment of equities could lift domestic ownership of Japanese equities.
5. Higher valuations: A comparison of Asian and emerging equity markets based on price-to-book ratio and return on equity found that the MSCI Japan index, which measures the performance of large and mid-cap segments, would be trading around 25% above current valuations, driven in part by higher nominal growth expectations.
6. Better Corporate Governance. As a result of a decade of reforms, Japanese corporates are much more focused on financial performance, as shown in the rise of ROE from 8.1% in 2014 to 9.3% in 2024.

Japan’s era of nominal growth coincides with a national “grand strategy,” born under PM Shinzo Abe and continued by all subsequent prime ministers. To achieve the aspirations of national security and economic prosperity, Japan is improving its capabilities – and hopes to overcome adverse demographic trends at home and geopolitics abroad.

“The grand strategy is expected to bring big changes, especially to sectors such as energy, agriculture, health care, artificial intelligence, and education,” says Robert Alan Feldman, Senior Advisor at Morgan Stanley MUFG Securities. “And raise income for both capital and labor.” 

To achieve its aspirations, Japan must move quickly and decisively in five areas.

• Faster technology diffusion: Economic transformation depends on the rapid diffusion of technology. The Japanese government and companies have excelled at developing technological solutions yet need faster decision-making and action.
• Greater labor market liquidity: New technology cannot spread without a workforce that is able to change jobs and adapt skills. Companies will need to invest in reskilling the labor force.
• Better public governance. Japan needs faster public decisions to improve efficiency of pensions, medical care, and welfare. Recent electoral system reforms will help.
• Better corporate governance: The private sector has made great progress in corporate governance, but still needs more attention to financial efficiency.
• Fiscal rebalancing:  Technology-based cost reductions would reduce the need for tax hikes.

"Room for improvement is quite substantial and suggests that investor attention to the progress of Japan's emerging grand strategy is warranted," says Feldman.

When considering which investments may fit into your portfolio, be sure to keep in mind individual goals, timelines, and risk tolerance.

CRC# 4068660 03/2025