Japan’s Market: A Cautious Assessment

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The recent performance of the Japanese stock market is, on the surface, encouraging. Over the past year, the Nikkei 225 has outpaced both the S&P 500 and broader global indices. A gain of 38.6% since January 2025, compared to 15.7% for the S&P 500 and 21.3% for a broad world stock ETF, is a figure that naturally attracts attention. However, it is a mistake to view such numbers in isolation. The history of the Japanese market is littered with false dawns, and a degree of skepticism is warranted.

For decades, Japan was synonymous with economic stagnation – the so-called ‘lost decades’ following the bursting of the asset bubble in 1989. The current upturn, therefore, demands closer scrutiny. Is it a genuine recovery, or merely a temporary reprieve fueled by speculative fervor?

For those inclined to invest, the iShares MSCI Japan ETF (EWJ +0.68%) offers a relatively straightforward means of gaining exposure to the Japanese market. It has, indeed, delivered a respectable return of 29.2% over the last year. But the question is not merely what has happened, but what is likely to happen next.

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Reasons for Cautious Optimism

Several factors are currently contributing to the positive sentiment surrounding Japanese stocks. It is important to assess these with a clear head, separating genuine progress from political posturing.

  • Government Spending: The election of Sanae Takaichi as Prime Minister and her pledge to stimulate the economy through increased government spending is, at first glance, positive. However, history teaches us that government intervention is rarely a panacea, and can often create more problems than it solves.
  • Political Capital: Takaichi’s current approval rating (64% as of December 2025) is undoubtedly a benefit. But popularity is a fickle thing, and can evaporate quickly in the face of economic headwinds.
  • Corporate Governance: Recent changes to corporate governance regulations are a step in the right direction, aimed at making Japanese companies more accountable to investors. Whether these changes will be sufficient to overcome decades of entrenched practices remains to be seen.
  • U.S. Economic Growth: Continued growth in the U.S. economy, which accounts for 21% of Japanese exports as of 2024, is undoubtedly beneficial. However, reliance on a single market leaves Japan vulnerable to external shocks.

The ETF’s top holdings – Toyota Motor (4.59%), Mitsubishi UFJ Financial Group (4.43%), Hitachi (3.20%), Sony Group (3.13%), and Sumitomo Mitsui Financial Group (2.71%) – represent a concentration of established, large-cap companies. While diversification within the ETF is reasonable, the overall portfolio is heavily weighted towards these few names. The expense ratio of 0.49% is acceptable, though not negligible.

It would be foolish to ignore the risks. A decline in Prime Minister Takaichi’s popularity could lead to political gridlock and derail much-needed reforms. More concerning, perhaps, is the potential for inflation. Increased government borrowing, coupled with a weakening yen, could create a dangerous spiral. The existing 15% tariff on Japanese imports into the U.S., imposed in July 2025, represents a significant headwind, and any escalation of trade tensions would be detrimental.

Valuation: A Modest Advantage

Despite recent gains, Japanese stocks appear, on a trailing twelve-month price-to-earnings basis, to be somewhat undervalued compared to their American counterparts. The iShares MSCI Japan ETF currently trades at a P/E ratio of 19.9, compared to 31.3 for the S&P 500. This discrepancy, however, is not dramatic, and does not necessarily indicate a clear buying opportunity.

If Prime Minister Takaichi and her government can genuinely unleash economic stimulus, drive meaningful corporate governance reforms, and avoid the pitfalls of excessive inflation, the Japanese market may indeed sustain its momentum in 2026. The iShares MSCI Japan ETF offers a convenient means of gaining exposure to this potential growth. However, investors should proceed with caution, recognizing that the path to recovery is likely to be long and arduous. The past, as always, casts a long shadow.

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2026-01-21 22:02