The unwinding of the long-standing yen carry trade in 2024 sent shockwaves through global markets, particularly impacting Japan’s stock market. As the dust settles, investors are looking ahead to 2025 with cautious optimism, driven by reasonable valuations, corporate reforms, and improved shareholder returns. Here’s a breakdown of what happened, what’s driving Japan’s markets now, and where the opportunities lie.
What Happened in 2024?
Japan’s Topix index had surged 23% by July 2024, building on a 25% gain from the previous year. However, the tide turned as concerns about a potential US recession and interest rate hikes by the Bank of Japan (BoJ) triggered a massive unwinding of the yen carry trade. This strategy, which involved borrowing in low-yielding yen to invest in higher-yielding assets, became less attractive as Japan’s rates rose and US rates were expected to fall.
The fallout was significant: the Topix tumbled, and despite a partial recovery, it remains 5% below its July 2024 peak. The increased volatility led many investors to reduce their exposure to Japanese stocks, creating a challenging environment for the market.
What’s Driving Japan’s Markets in 2025?
Three key factors are likely to shape Japan’s stock market in 2025:
- Reasonable Valuations
Japan’s stock valuations remain attractive, with the Topix trading at a price-to-earnings (P/E) ratio of around 14x based on consensus earnings forecasts for the year ending March 2026. Profits are expected to grow by nearly 10%, providing a solid foundation for potential gains. Ongoing corporate reforms and the return of healthy inflation levels could further bolster the market, offsetting risks from US tariffs or China’s economic slowdown. - Inflation and Wage Growth
After decades of deflation, Japan is finally experiencing sustained inflation, prompting the BoJ to raise interest rates to 0.25% – the highest level since 2008. The upcoming “shunto” wage negotiations in spring 2025 could see unions demanding a 5% pay increase for the third consecutive year. Higher wages and inflation are likely to encourage individuals to shift from cash holdings to stocks, seeking better returns. - Corporate Reforms and Shareholder Returns
The Tokyo Stock Exchange (TSE) has been pushing companies to improve capital efficiency through share buybacks, dividend payments, and unwinding strategic shareholdings. These reforms have already boosted return on equity (ROE) and are expected to continue driving shareholder-friendly changes in 2025. Activist investors and increased mergers and acquisitions (M&A) activity are also contributing to a more dynamic market. Notably, Toyota Motor’s ambition to nearly double its ROE to 20% signals the potential for further upside in Japanese stocks.
Where Are the Opportunities?
While risks such as US tariffs and China’s economic slowdown persist, focusing on domestically oriented companies could help mitigate these challenges. Here are some areas to consider:
- Financials: Banks like Mitsubishi UFG Financial Group (MUFG) are well-positioned to benefit from higher interest rates and exposure to the US economy, with less vulnerability to tariff risks. MUFG’s American Depositary Receipt (ADR) listing makes it accessible to US investors.
- Small- and Mid-Cap Stocks: Companies with more domestic demand exposure can be accessed through ETFs like the iShares MSCI Japan Small-Cap ETF (SCJ). Active funds such as the Hennessy Japan Small Cap Fund (for US investors) and the Nippon Active Fund or AVI Japan Opportunity Trust (for UK investors) may also offer opportunities.
- Growth Stocks: For those looking to capitalize on emerging trends, Harmonic Drive, a small-cap company poised to benefit from the rise of humanoid robotics, could be an intriguing option.
Conclusion
The collapse of the yen carry trade in 2024 marked a turning point for Japan’s markets, but 2025 offers a fresh start. With reasonable valuations, inflation-driven wage growth, and ongoing corporate reforms, Japan’s stock market could see renewed momentum. By focusing on domestically oriented companies and leveraging active investment strategies, investors may find compelling opportunities in the land of the rising sun
