Why Japanese Stocks Could Keep Rallying

Market Performance and Catalysts

• Japanese equities extended gains following a strong 2025, driven primarily by Prime Minister Senei Takeuchi's resounding snap election victory.
• Goldman Sachs Research raised its target on Japanese equities, citing the election result as a positive catalyst for the market.
• The Nikkei has outperformed the US dollar-adjusted benchmarks in 2026, rising approximately 14% year-to-date compared to flat performance for the S&P 500 and a 2% decline for the Nasdaq.

Historical Election Precedents and Valuation Mechanics

• Historical analysis of three previous LDP supermajorities (2005, 2012, 2014) shows an average market gain of 20% within the first three months following the election.
• Following the initial surge, market multiples expanded to peak three points higher than pre-election levels before settling at a sustainable two-point premium.
• This multiple expansion is attributed to increased political stability, as the average tenure of a Japanese Prime Minister post-WWII is only 1.5 years, whereas a supermajority suggests longer-term governance.
• Greater policy continuity is expected to lower the market risk premium and attract increased foreign investor participation.

Policy Expectations and Fiscal Outlook

• Market clarity is anticipated in the near term regarding defense, economic security, and Japan-US relations, particularly ahead of the March 19 summit between Prime Minister Takeuchi and President Trump.
• Investors are monitoring a proposed two-year cut to the consumption tax on food, with concerns that reversing this measure in the 2028 Upper House election could be politically difficult.
• Despite initial fiscal concerns, Takeuchi's landslide victory likely reduces the probability of radical populist fiscal policies, as the administration feels politically secure for four years in the Lower House.
• Market reactions in FX and rates markets indicate increased relaxation regarding the fiscal outlook compared to pre-election levels.

Corporate Governance and Structural Reforms

• Corporate governance reform efforts, reignited in early 2023, have driven total shareholder returns from 6–7 trillion yen annually pre-Abenomics to 40–45 trillion yen annually currently.
• Foreign investors continue to demand greater urgency in reforms, citing flatlining Return on Equity (ROE) which remains stagnant between 9% and 10%.
• Goldman Sachs projects the next market phase requires acceleration of ROE improvement through aggressive shareholder returns, growth investment, sector consolidation via M&A, and restructuring of under-scale listed companies.
• Top-down pressure from the Tokyo Stock Exchange, METI, and the FSA is expected to be critical to maintaining momentum and aligning with bottom-up investor engagement.

Investment Flows and Allocation Potential

• Net foreign positioning in Japanese equities has recovered to pre-Bank of Japan volatility levels seen in July 2024, following a 13 trillion yen outflow after the summer 2024 correction.
• Current mutual fund data indicates foreign investors remain underweight Japan compared to levels seen at the start of Abenomics in late 2012.
• Foreign buying reached 1.8 trillion yen in the week prior to the election, the second-highest on record, pushing year-to-date flows to 3.4 trillion yen.
• Geographic diversification flows out of the US and into Japan are accelerating, evidenced by increased attendance of US allocators at recent Tokyo investor conferences.

Market Cycle Outlook and Risks

• Goldman Sachs views the current market as being in the upward phase of a cycle that began in autumn 2022, with multiples more than doubling since then.
• The subsequent phase is defined as the "delivery phase," where sustained valuation re-rating depends on tangible proof of corporate transformation and ROE growth.
• Primary risks to the bullish thesis include the potential unexpected resignation of Prime Minister Takeuchi, which historically correlates with the end of market rallies.
• Secondary risks involve policy missteps that could unsettle bond or FX markets, as well as external shocks to the US economy or global geopolitical events.
• Volatility remains a concern given the unusual trend of no significant (>5%) corrections in the 12 months since April 2024, a deviation from the typical three annual correction frequency.