Why Japanese equities look attractive in 2026 – Part two

In Part 1 of this two-part series, we saw that Japanese equities still looked relatively cheap and potentially had room to grow and that the country’s role in the tech sector and global supply chain allowed it to profit from the AI boom with more reasonable stock market valuation. In this article, we will have a look at two other factors supporting the idea that an investment in the Japanese stock market could still provide an opportunity in 2026. 

Let’s take a closer look:

Japan’s economy proves it no longer needs Central Bank crutches

For decades, investors have defined Japan’s economic situation as deflationary, with stagnant wages, and ultra-loose monetary policy. The Bank of Japan became synonymous with extraordinary stimulus measures—negative interest rates, aggressive bond purchasing, and yield curve control—all designed to jumpstart an economy trapped in a deflationary spiral. 

But 2025 marked a fundamental turning point. Japan’s economy is demonstrating it can sustain growth without monetary life support, and rising interest rates are signaling confidence rather than concern. This shift could represent one very compelling reason to view Japanese equities favorably in 2026: when a central bank can raise rates without significantly derailing economic recovery, it signals underlying strength—precisely the kind of structural improvement that attracts long-term investment capital.

The Bank of Japan raised borrowing costs to a 30-year high in December 2025, bringing rates to 0.75%. This move might seem modest by global standards, but it represents a seismic shift for an economy that endured negative rates and deflation for decades. More significantly, the economy seems to have absorbed these increases without really faltering, demonstrating resilience that would have seemed nearly impossible just years ago.

The Bank of Japan will continue to normalize interest rates as long as the economy performs as expected, according to recent comments from Governor Kazuo Ueda. “Wages and prices are highly likely to rise together moderately,” Ueda explained in a speech to Japan’s banking sector, adding that “adjusting the degree of monetary support will help the economy achieve sustained growth.” This isn’t the language of a central banker worried about fragility—it’s the confident assessment of an economy entering a virtuous cycle.

The BOJ’s quarterly outlook report, due at its January 22-23 policy meeting, will provide further clarity on the board’s inflation outlook and rate trajectory. The summary of opinions from the bank’s latest meeting pointed clearly toward additional rate increases ahead, with some board members advocating for further steady hikes as yen weakness pushes up import costs and broader inflation.

What underpins the sustainability of Japan’s monetary normalization is the emergence of genuine wage-driven inflation. Governor Ueda has repeatedly stressed that further rate increases can only be justified if price pressures are supported by rising domestic wages. While higher goods’ prices initially eroded real purchasing power, labour market dynamics have shifted, giving unions greater leverage to secure meaningful pay increases.

Rengo, Japan’s largest labour union federation representing around seven million workers, is calling for wage hikes of 5% or more in 2026. This follows a similar demand in 2025, which led to the largest pay increase in more than three decades. According to Keidanren, the country’s leading business lobby, major Japanese companies delivered an average wage increase of 5.39% last year, marking the second consecutive year in which pay growth exceeded 5%.

Most importantly, corporate leaders have signalled their intention to maintain this momentum. Speaking at a New Year event in Tokyo, FamilyMart president Kensuke Hosomi said the company aims to exceed last year’s wage increases in the upcoming shuntō spring negotiations. Other executives echoed this stance, highlighting higher wages as a strategic necessity to attract and retain talent, including positioning Japan as a more appealing destination for foreign workers.

The remaining challenge lies in spreading these gains beyond large corporations to small and medium-sized enterprises, a central issue in the upcoming March wage talks. Achieving broader-based pay growth would strengthen domestic demand and further solidify the foundations of Japan’s economic recovery.

For equity investors, Japan’s ability to normalize monetary policy without major economic disruption carries profound implications. Rising rates typically strengthen currency stability, improve bank profitability, and signal confidence in corporate earnings sustainability. After years of negative real wage growth despite headline inflation, Japan appears poised to achieve genuine income-driven consumption growth—the kind that supports durable corporate revenue expansion.

Japan’s economy no longer needs crutches. After three decades of extraordinary support, it’s learning to walk on its own. For investors, this newfound strength suggests Japanese equities could sustain their momentum well into 2026 and beyond, supported by fundamentals rather than central bank interventions. That’s the kind of foundation on which lasting bull markets are built.

Corporate governance changes could be unlocking Japanese value

For a long while, Japanese companies were notorious for prioritizing corporate stability over shareholder returns. Massive cash hoards sat idle on balance sheets, cross-shareholdings entrenched management from accountability, and returns on equity languished far below other developed markets. But a quiet revolution has been underway since 2012, and it’s fundamentally reshaping the investment case for Japanese equities.

The corporate governance reforms initiated during Shinzo Abe’s second tenure as prime minister are now producing tangible, measurable results. What began as regulatory encouragement has evolved into structural change, transforming how Japanese companies allocate capital, compensate shareholders, and measure success. For investors, this transformation still represents an opportunity in 2026: exposure to companies with significant room for profitability improvement, trading at reasonable valuations in a supportive policy environment.

The year 2025 marked the 10th anniversary of Japan’s Corporate Governance Code, which was designed to strengthen oversight and accountability at listed companies. Corporate cross-shareholdings we mentioned above—the practice of companies holding each other’s stock to cement business relationships and insulate management—have plummeted from over 60% in 1990 to around 25% by the end of 2023, according to Japan Exchange Group data. As these defensive structures unwind, foreign investors now hold 32% of Japanese equities, bringing greater pressure for performance and transparency.

The revision of the Corporate Governance Code, the first in five years, expected mid-2026, might change the corporate governance rules again. This update is expected to intensify scrutiny on corporate cash hoarding, requiring companies to justify the rationale for maintaining such substantial reserves. The implications extend beyond dividends and buybacks. As companies face pressure to rationalize cash holdings, they will also need to reconsider wage levels. Higher wages would fuel consumption growth, creating a virtuous cycle that benefits both shareholders and the broader economy.

Rising deal activity in Japan reflects a surge in investor confidence, with global financial leaders increasingly deploying capital into the region. Goldman Sachs recently committed to scaling its Japanese corporate investments by roughly ¥800 billion ($5.1 billion) over the coming decade, focusing specifically on mid-cap firms in the ¥30 billion to ¥300 billion range. This momentum follows a record-breaking 2025, where deal volumes reached $350 billion, a peak likely driven by corporate governance reforms designed to maximize shareholder returns.

Citigroup is similarly bullish, planning to expand its Japanese investment banking division by roughly 30% by the first half of 2026 to capitalize on what it expects will be continued M&A momentum, as Japanese executives and directors have become meaningfully more attuned to shareholder needs, making strategic deals increasingly viable.

The allure of Japanese corporate reform lies in the sheer scale of available upside. For decades, a zero-interest-rate environment provided cheap funding that masked deep-seated inefficiencies, leading to the lowest Return on Equity (ROE) in the developed world. However, as interest rates normalize and capital becomes more expensive, Japanese management teams are finally under real pressure to optimize performance.

Morgan Stanley recently forecast that Japanese companies could achieve returns on equity of 13% by 2030—up from current levels in the high single digits. If realized, this would represent a re-rating opportunity. The path to improvement is straightforward: divest underperforming divisions, rationalize competition, increase operating leverage, and distribute excess cash. Unlike highly optimized U.S. companies where further efficiency gains are marginal, Japanese firms can meaningfully improve profitability through operational discipline alone.

For equity investors, Japan’s evolving corporate governance provides a path toward returns that remains largely insulated from global trade tensions and economic shifts. The reforms are structural, policy-supported, and accelerating. As Japanese companies transition from cash hoarders to shareholder-focused operators, the valuation gap between Japanese and global equities should narrow—creating sustained appreciation potential for those positioned early in this multi-year transformation.