Japan: What to expect in 2025

Fidelity Japan Trust portfolio manager Nicholas Price shares his outlook for 2025 and provides an insight into how he is looking to position the portfolio against an evolving macro backdrop.

What is your outlook for your asset class?

Global markets reacted immediately to Donald Trump’s election victory and Japan was no exception, with key indices enjoying a lift. While the initial impact quickly faded, concerns over the pursuit of protections trade policies are set to linger. In this environment, I am looking towards domestic Japan-oriented mid caps that are generally inoculated from external macro risks, and beneficiaries of reshoring in the United States.

In Japan, monetary policy is on the path to normalisation and the annual spring labour negotiations are likely to deliver a further c.3% increase in base wages next year, a level that the Bank of Japan (BoJ) views as a requisite for sustainable inflation. Despite losing their Parliamentary majority, the Liberal Democratic Party and its junior partner Komeito are likely to cooperate with opposition parties on specific legislation, with a focus on economic stimulus and regional revitalisation ahead of Upper House elections in July 2025. Harsher-than-anticipated tariffs or some other exogenous shock leading to a sharp deceleration in global growth are potential risk factors ahead.

Corporate governance reforms have led to a surge in share buybacks and dividends. Nevertheless, cash balances have continued to accumulate on corporate balance sheets despite record payouts, and more than 50% of listed companies in Japan are still net cash. The pressure from the Tokyo Stock exchange (TSE) and shareholders to improve capital efficiency, combined with Japan’s shift to moderate inflation, means that there is plenty of incentive for companies to do more.

We are also seeing a clear increase in corporate activity through management buyouts, takeover bids and mergers and acquisitions more broadly, as well as an acceleration in the unwinding of cross shareholdings. In an historically overcapitalised market where there is a clear drive to improve capital efficiency and restructure balance sheets, this trend of de-equitisation is positive for the mid-to-long term outlook.

How are you looking to position your portfolio against this backdrop?

For the first time in three years, the outlook for corporate earnings is less dependent on currency factors and I see the potential for laggard domestic mid caps to perform. This segment of the market has seen valuation multiples compress to historical lows and tends to be relatively insulated from external macro developments.

Meanwhile, Japan-specific drivers, such as domestic reflation and rising wages, and TSE-led governance reforms represent multi-year structural trends that are creating new investment ideas. The initial governance charge was led by low price-to-book companies and while most of the low hanging fruit has been harvested, I see greater potential for change among mid caps and sustainable growth companies.

The reflation story in Japan, fuelled by a shift in price and wage setting behaviour, is supporting a pickup in consumption that selected speciality retailers are well positioned to capture through new store openings and popular product lines. At the same time, strong sales growth and price hikes are leading to lower discounts and higher profit margins.

Among global cyclicals, Japanese factory automation (FA) companies have massively lagged their semiconductor-related peers and I see the potential for this to reverse as the direction of US policy becomes clearer and China implements further stimulus measures. At the same time, Japanese industrials that are well placed to capture reshoring demand in the US also look attractive.

With the BoJ on the path to policy normalisation, I have a strategic overweight in selected mega banks, focusing on companies that offer the highest relative upside potential in the sector. Conversely, I am avoiding companies that are ill placed to navigate rising geopolitical fragmentation and whose production footprint leaves them susceptible to isolationist trade policies.

Important information
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Fidelity Japan Trust PLC invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. Changes in currency exchange rates may affect the value of investments in overseas markets. The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. This investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. Investors should note that the views expressed may no longer be current and may have already been acted upon.