For over a decade, the default recommendation for retail investors worldwide has been simple: buy a global index fund and forget about it. The MSCI All Country World Index — or its close cousin, the S&P 500 — became the intellectual path of least resistance. And for a long time, it worked beautifully.

But the conditions that powered that trade are shifting. After three decades in Japan’s institutional investment industry, I believe we are entering a period where Japanese equities will meaningfully outperform global indices. This is not a short-term tactical call. It is a structural argument built on five mutually reinforcing pillars.

The Thesis in Brief

Japan is experiencing a once-in-a-generation convergence: the end of deflation, a corporate governance revolution, massive shareholder returns, renewed foreign investor interest, and a growth-oriented government with an electoral supermajority. Meanwhile, the global index funds that most investors hold are heavily concentrated in US mega-cap technology stocks trading at historically elevated valuations.

The asymmetry is striking.

Pillar 1: The End of Deflation

Japan’s consumer price index has remained above the Bank of Japan’s 2% target for 45 consecutive months as of December 2025, according to government statistics. This is not a blip. Core inflation — excluding fresh food and energy — has been running above 2% for over three years.

For investors outside Japan, it is difficult to overstate what this means. Deflation was not merely an economic statistic in Japan; it was a psychological condition that suppressed consumption, investment, wages, and equity valuations for an entire generation. Its end changes the fundamental calculus for Japanese assets.

Wages are now rising in response. The 2025 Shunto spring wage negotiations delivered nominal pay increases exceeding 5% at major companies, and real wage growth has begun to turn positive. When workers expect prices and wages to rise, they spend differently. When companies expect demand to grow, they invest differently. When investors see nominal growth, they value equities differently.

The Bank of Japan has responded by gradually normalising monetary policy, raising its benchmark rate to 0.5% as of January 2025. Real interest rates remain deeply negative, meaning monetary conditions are still accommodative even as the direction of travel has changed. This is precisely the sweet spot for equity markets: enough inflation to drive nominal growth, but not so much tightening as to choke it off.

Pillar 2: The Corporate Governance Revolution

In March 2023, the Tokyo Stock Exchange issued a directive that sent shockwaves through corporate Japan: companies trading below a price-to-book ratio of 1.0 were asked to disclose concrete plans for improvement or explain why their capital allocation was acceptable. This was not a suggestion. It was a public naming exercise with real reputational consequences.

The results have been dramatic. According to J.P. Morgan Asset Management, 94 companies were delisted from the TSE in 2024 in a quality drive — the highest number since 2013 and the first-ever net decrease in listed companies. The TSE is actively shrinking itself to raise quality.

Share buybacks tell the most compelling part of the story. Nippon.com reports that authorised buybacks reached ¥14.2 trillion by December 2025, on track to match or exceed the previous year’s record of ¥18.7 trillion. Asset Management One’s 2026 outlook projects buybacks exceeding ¥20 trillion in FY2025, with sizeable volumes expected for the next several years.

Major transactions illustrate the new mindset. Mitsubishi Corporation authorised a ¥1 trillion buyback. Shin-Etsu Chemical and Fanuc each announced buybacks of up to ¥500 billion. According to McKinsey’s analysis, Japanese nonfinancial companies still hold over $1 trillion in cash — the highest cash-to-market-cap ratio amongst developed markets. The runway for further capital return is enormous.

Cross-shareholdings, long a drag on governance and capital efficiency, are being unwound. Nomura estimates they now represent roughly 25% of TSE market capitalisation, down from about 60% in 1990. Major banks and insurers have committed to continue selling cross-held shares through FY2030. As these stakes are sold, the proceeds flow into buybacks and dividends, creating a virtuous cycle.

The Financial Services Agency published its “Action Programme for Corporate Governance Reform 2025” in June 2025, targeting excessive cash hoarding and demanding accountability for capital allocation. A further revision of the Corporate Governance Code is expected by mid-2026.

Return on equity, historically Japan’s Achilles heel, is catching up. Japan’s total shareholder return ratio in FY2024 reached parity with European companies at roughly 60%, according to Janus Henderson.

Pillar 3: The Valuation Gap

Despite all of this improvement, Japanese equities trade at a substantial discount to their US counterparts. On an MSCI ACWI ex-US basis, Japan’s forward P/E ratio sits at approximately a 36% discount to the US market. For investors allocating through a global index fund, roughly 65% of their exposure is in US equities — predominantly mega-cap technology companies whose valuations assume continued dominance of global profit pools.

This concentration risk is rarely discussed. An investor who buys a global index fund today is making a massive bet on the continued outperformance of a handful of US technology stocks. Japanese equities, by contrast, offer diversified exposure across industrials, financials, healthcare, consumer goods, and technology at far more reasonable valuations.

The TOPIX index hit record highs in 2025, rising approximately 38% over the trailing twelve months. Yet unlike the US market, where a narrow group of mega-caps drives index returns, Japan’s rally has been broadening. Invesco’s 2026 outlook expects market rotations to widen beyond AI and semiconductor themes, favouring companies with strong fundamentals across diverse sectors.

Pillar 4: Foreign Investors Are Coming Back

Nikkei Asia reported in December 2025 that net foreign buying of Japanese equities was on track to reach its highest annual total since the early days of Abenomics in 2013 — approximately $38 billion. North American investors specifically were set for their highest net buying since 2014.

The week ending 4 October 2025 saw a record single-week foreign inflow of ¥2.48 trillion ($16.26 billion), coinciding with Sanae Takaichi’s election as LDP leader and subsequently Prime Minister. According to Japan’s Ministry of Finance, this was the largest weekly inflow since at least 2005.

The drivers are structural, not merely tactical. The “sell America, diversify globally” theme gained momentum throughout 2025 as US tariff policy created uncertainty. But beyond rotation out of the US, Japan offers something affirmative: genuine corporate reform, reasonable valuations, and a growth-oriented policy framework.

Domestic flows are also strengthening. Japan’s NISA tax-advantaged investment programme has attracted over 26 million accounts with cumulative purchases exceeding ¥63 trillion. Roughly half of new NISA investment has been directed into Japanese equities, representing a meaningful shift in household behaviour after decades of near-exclusive allocation to bank deposits.

Pillar 5: A Growth-Oriented Government

Prime Minister Sanae Takaichi won a landslide victory in the 8 February 2026 snap election, with her LDP-Ishin coalition securing 352 seats in the 465-member Lower House — surpassing the two-thirds supermajority threshold. This gives her government the parliamentary authority to pursue its agenda without opposition support.

The Takaichi administration’s economic programme centres on three pillars. First, a ¥21.3 trillion comprehensive stimulus package approved in November 2025, focused on cost-of-living relief, strategic investment, and defence. Second, strategic investment across 17 priority sectors including AI, semiconductors, quantum computing, and shipbuilding. Third, a defence buildup targeting 2% of GDP, with the FY2026 budget allocating approximately ¥9 trillion for defence.

The FY2026 initial budget of ¥122.3 trillion is the largest in Japanese history. Whilst fiscal sustainability is a legitimate concern — Japan’s debt-to-GDP ratio exceeds 230% — the Takaichi government has framed its approach as “responsible and proactive public finances,” using higher-than-expected tax revenues to partially fund the expansion.

For equity investors, the policy mix of fiscal expansion, corporate governance reform, and strategic industrial investment creates a favourable backdrop. The government is actively working to boost nominal GDP growth, raise wages, and attract both domestic and foreign investment.

What About the Risks?

No investment thesis is without risks. The most significant include:

Yen appreciation. If the yen strengthens sharply — for example, in response to Fed rate cuts under incoming Chair Kevin Warsh or BOJ rate hikes — it could create a headwind for exporter earnings. However, for foreign investors, yen appreciation is a tailwind, boosting returns when converted back to their home currency.

US policy uncertainty. Tariff policy, trade negotiations, and the evolving US-Japan investment framework (including Japan’s $550 billion US investment commitment) introduce uncertainty. However, the US-Japan trade deal finalised in September 2025 has reduced the most acute risks.

BOJ policy error. If the Bank of Japan tightens too aggressively, it could undermine the nascent recovery. Governor Ueda has signalled a cautious approach, and the government has made clear its preference for accommodative conditions.

Global recession. A severe global downturn would affect all equity markets, including Japan. However, Japan’s domestic demand recovery, fiscal stimulus, and structural reforms provide some insulation.

The Bottom Line

The case for Japanese equities is not about one data point or one quarter. It is about a structural transformation that has been building for years and is now reaching critical mass. Deflation is over. Corporate governance is being reformed at an unprecedented pace. Shareholders are being rewarded with record buybacks and dividends. Foreign and domestic investors are returning. And the government has the mandate and the will to pursue growth.

If you are allocating your portfolio through a global index fund, you are implicitly underweight this story. Japan represents roughly 5–6% of the MSCI ACWI, whilst the US accounts for approximately 65%. In a world where the US market’s concentrated bet on technology faces increasing headwinds, and Japan’s broad-based reform story is just gaining momentum, that allocation may be leaving significant returns on the table.

I am Gyokuro (玉露), a pen name. I have spent 30 years in Japan’s institutional investment industry and currently advise companies on capital markets in Tokyo. This site carries no advertising and no affiliate links. If you find the content valuable, you can support the site here. This article represents my personal views and does not constitute investment advice. Past performance does not guarantee future results. All investments involve risk, including the potential loss of principal. Please consult a qualified financial adviser before making investment decisions.