Unlocking Japan’s equity edge in a shifting global landscape

Fidelity

In the shadow of global volatility and uncertain trade dynamics, Japan is quietly staging a comeback. Structural shifts in wage growth, corporate reform and valuation gaps are converging to create a once-in-a-decade investment opportunity. For investors seeking overlooked potential, Japan’s equity market is offering fertile ground—especially in the mid and small-cap space.

Despite recent underperformance, Japan’s equity outlook is brightening as structural tailwinds take hold. The domestic economy is seeing genuine signs of reflation, led by meaningful wage growth. The Japanese Trade Union Confederation’s call for a 6.09% wage hike in 2025—its highest since 1993—signals a powerful shift in worker bargaining power. Over 60% of companies now plan to raise wages, driving the fastest base pay increase in more than three decades. With the Bank of Japan maintaining accommodative monetary policy despite a rate hike to 0.5%, inflation-adjusted interest rates remain deeply negative, fuelling demand-led economic expansion.

Corporate governance is undergoing a sweeping transformation. Over 90% of Prime Market companies and nearly half of Standard Market firms have responded to the Tokyo Stock Exchange’s call for capital efficiency and transparency. These reforms, once concentrated in large-cap sectors like banking and shipping, are now broadening to mid and small-cap firms. The result: a marked uptick in shareholder returns and renewed investor engagement.

Valuations are particularly compelling in the mid/small-cap segment. These companies are trading at a steep discount to their large-cap counterparts and have shed the price-earnings premiums that dominated previous decades. Many boast strong balance sheets and ample cash reserves, enabling buybacks and strategic acquisitions. As they align with TSE reform mandates, these firms are poised to benefit from re-rating potential and improved capital efficiency.

Corporate activity is surging. Management buyouts, mergers, and a drive to unwind cross-shareholdings underscore Japan’s evolving corporate landscape. With more than three times the number of listed subsidiaries as the US and over half trading below book value, Japan is becoming a hotspot for restructuring and private equity interest. This de-equitisation trend is streamlining capital structures and supporting a long-term bull case.

Fundamentally, the earnings picture is robust. Fiscal Q3 2024 results exceeded expectations, led by strong non-manufacturing revenue and manufacturing profit growth, boosted by currency tailwinds. Upward earnings revisions outpaced downgrades, reflecting a resilient domestic economy. Meanwhile, valuation multiples remain attractive. The TOPIX index trades at a 33% discount to the S&P 500, suggesting significant upside potential.

Japan presents a rich seam of underappreciated companies, especially in the growth-oriented mid/small-cap segment. With lower analyst coverage and superior business models, these firms offer active managers the chance to discover mispriced assets and hidden champions. For investors willing to look beyond the noise of geopolitics, Japan’s reformed, reflating and undervalued equity market could be the most compelling opportunity of the decade.

Fidelity Japan Trust provides exposure to Japan’s most promising listed and pre-IPO companies, harnessing local expertise to uncover long-term value in a market undergoing structural change.

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