Tokyo. The Nikkei stock index has risen by more than 13.4 per cent since the start of the year - a highly respectable performance. What is striking, however, is that Japanese equities achieved this gain in less than two months.
Investors in Japanese assets have welcomed the surge. The performance is all the more notable given that it comes at a time when US equities are treading water: the S&P 500 index has remained marginally in negative territory, down 0.03 per cent. Financial markets tend to follow perceived leadership, and if the divergence persists for several months, capital flows may increasingly shift from the United States towards Asia.
The rally in Japan was fuelled in part by the re-election of Prime Minister Sanae Takaichi. So far, markets have responded favourably. Yet sentiment is driven by more than image. Investors are unlikely to be swayed by anecdotes about riding a Kawasaki motorcycle or having played drums in a heavy metal band in earlier years. What matters to financial markets are the concrete policy steps the prime minister intends to take.
The strategy of Sanaenomics and the risk of debt
There are several reasons why markets are enthusiastic about Sanae Takaichi. Most broadly, the prime minister believes that renewed growth will come from “kick-starting” Japan’s export machine. In practical terms, she appears determined to do whatever is necessary to put the economy back on a stronger footing, an approach that investors tend to welcome.
Another factor is the strength of her electoral mandate. The LDP secured 316 seats, a significant increase on the 196 it held before the snap election. The triumph of “Sanaenomics” was so decisive that it reportedly surprised even the party itself.
Japan’s electoral system allows candidates to stand both in single-member constituencies and on proportional representation lists. In this case, LDP candidates won so many constituency races that the party effectively exhausted its list. Although it was entitled to a further 14 seats based on its share of the vote, it was unable to fill them because it had no remaining list candidates.
The scale of the mandate therefore appears substantial. Political instability is not an immediate concern, and investors can take comfort from that. The LDP can hardly argue that it lacks the parliamentary strength required to implement reforms and pursue its growth agenda.
Japan’s new course is expected to be firmly pro-growth. Sanaenomics envisages extensive subsidies, sizeable tax relief and state-backed industrial investment in strategic sectors such as semiconductors.
For domestic investors, the programme is appealing. Yet there is a significant constraint: the country’s already elevated public debt. Takaichi intends to stimulate the economy, but if tangible results fail to materialise swiftly, concerns about fiscal sustainability will resurface. It is evident that the proposed measures would, at least initially, add to the debt burden.
Should it become clear over time that the anticipated economic revival is not taking shape, market sentiment could shift rapidly. Yields on Japanese government bonds would likely rise, and given the close relationship between bond and equity markets, higher yields would tend to dampen demand for shares. The principal risk lies there: the bond market could alter the overall picture at short notice.
The battle over the yen and the stock market’s winners
One of the key pillars of the strategy is the preservation of a relatively weak yen. For exporters, the mechanism is straightforward: the softer the currency, the stronger their overseas earnings once repatriated. Yet maintaining such an exchange rate presupposes that the Bank of Japan will refrain from tightening monetary policy too aggressively in response to inflation. Any credible signal of higher interest rates would risk strengthening the yen and undermining the export-led approach.
At the same time, excessive depreciation carries its own dangers. When the exchange rate recently approached 160 yen to the dollar, Japanese authorities intervened to stabilise the currency. Such action was not symbolic; it reflected concerns that a sharply weaker yen could unsettle global financial markets and provoke political tensions. An overly depreciated currency would also begin to weigh on American manufacturers. The episode effectively marked a boundary: while Tokyo favours a competitive exchange rate, there are limits beyond which further weakness becomes politically and economically costly.
The currency question could therefore complicate relations with Washington. Donald Trump and Sanae Takaichi both favour policies that support exports and curb imports, and both have shown tolerance for weaker currencies. Yet competitive devaluation cannot function smoothly if pursued simultaneously by two major economies. Managing the yen will thus become a delicate test of economic diplomacy. As exchange rates are increasingly shaped by political signalling rather than purely market forces, the environment also invites speculative capital flows, adding another layer of volatility.
At the company level, defence contractors in Tokyo have emerged as clear beneficiaries. Takaichi has indicated that she wants to raise defence spending to two per cent of GDP. Such commitments could also serve as leverage in negotiations with Donald Trump, potentially offsetting trade tensions.
The prime minister has further signalled her intention to pursue constitutional revisions that would loosen the post-war constraints on Japan’s military posture, while adopting firmer rhetoric towards China. Shares in groups such as Kawasaki Heavy Industries, IHI Corporation and Mitsubishi Heavy Industries have responded positively to the prospect of higher military outlays.
Japan also remains a technological powerhouse, and Takaichi has set the goal of achieving greater self-sufficiency in semiconductors and artificial intelligence. The government is therefore supporting the semiconductor industry as a whole. One of the strengths of the Tokyo market is the breadth of specialised firms, many of which occupy highly concentrated niches, if not outright dominant positions.
Disco manufactures precision equipment used to cut silicon wafers, a process essential to the production of advanced chips. Advantest is a leading player in semiconductor testing, including for companies such as Nvidia. Fujikura, meanwhile, produces optical fibre systems that are critical infrastructure for AI-driven data centres.
Banking on higher rates
Japanese banks may also emerge as quiet beneficiaries. Years of ultra-low or negative interest rates have weighed on the sector, as compressed borrowing costs squeezed net interest margins. That environment is gradually shifting. The adjustment is unlikely to be abrupt, but conditions are becoming more supportive for lenders.
If the broader economic recovery takes hold, bank shareholders could stand to gain. That outlook, however, rests on the absence of a disruptive shock, a risk that cannot be dismissed. The prime minister’s economic agenda amounts to a delicate balancing act.