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CONTRIBUTORS

Hsung Khoo

Portfolio Manager, Research Analyst,
Templeton Global Equity Group

Templeton Global Investments (TGI) is constructive on Japanese equities, as the country goes through its most significant economic and corporate transformation in a generation. The normalization of the Japanese economy after three decades of deflation is creating tailwinds for earnings growth. The pro-growth policies of the Takaichi administration should also provide a boost for Japan’s long-term growth potential. The broadening out of corporate reforms is transforming the metabolism of corporate Japan and driving what we view as a structural return-on-equity (ROE)1 improvement story.

These regime changes underpin multiyear earnings-per-share (EPS)2 growth that can drive returns for Japanese equities. This is likely to be accompanied by further upside from price-earnings (P/E)3 multiple rerating, as global investors embrace the revitalization of Japan’s economy and businesses.

Economic normalization drives multiyear earnings growth

The return of sustainable inflation has set Japan’s economy on a normalization path after three decades of deflation and stagnation. The ability to raise prices provides a long-absent tailwind for earnings growth.  We believe this is restoring animal spirits4 in corporate Japan.

Companies are now pursuing growth investments and strategic initiatives to become more competitive after years of underinvesting. They are also raising wages, and trickle-down effects for households are taking shape. The flywheel for a sustained normalization of the Japanese economy is in motion, and we believe this is supporting a multiyear earnings growth story for corporate Japan.

Meanwhile, the pro-growth policies of the Takaichi administration, which include targeted strategic investments, are likely to accelerate the ongoing normalization of the Japanese economy in our view, as well as raise the long-term growth potential for Japan. Policy support through public-private partnerships will take place in 17 strategic areas, such as semiconductors, artificial intelligence (AI), energy and defense. 

Exhibit 1: Return of Sustainable Inflation Is Driving a Convergence of Japan’s Nominal Gross Domestic Product (GDP) Growth Relative to G7

Source: Bloomberg. As of January 2026. The G7 includes Canada, France, Germany, Italy, Japan, the United Kingdom and the United States. Past performance is not necessarily indicative nor a guarantee of future performance.

Corporate reforms and ROE improvements

Corporate reforms are broadening out, and we think they are revitalizing corporate Japan. In the past, corporations showed a lack of attention to shareholder interests in Japan, but this is changing fast. The corporate reform movement has accelerated in recent years, and there is a growing focus on shareholder interests.

Corporate Japan is increasingly prioritizing the improvement of ROE, a measure on which many Japanese firms lagged their peers in the United States and Europe. While the initial focus was on improving capital efficiency by increasing dividend payouts and pursuing share buybacks, the focus is now broadening out to other forms of capital allocation discipline, such as selling non-core, underperforming businesses and redeploying the capital toward the core businesses. Corporate Japan is also now pursuing profit margin improvement through business portfolio restructuring and strategic initiatives to improve operational effectiveness. This goes beyond productivity improvement initiatives and includes a greater focus on product portfolio as well as pricing optimization.

The bottom line is that corporate reforms are driving a structural ROE improvement story in Japan.

Exhibit 2: Structural ROE Improvement in Japan

Source: Bloomberg. As of January 2026. The Tokyo Price Index (TOPIX) is a capitalization-weighted index tracking the performance of large firms listed in the first section of the Tokyo Stock Exchange. TOPIX500 is an index composed of 500 stocks with high market capitalization and liquidity among TOPIX constituents. The S&P 500 Index includes 500 leading companies in the United States and covers approximately 80% of available market capitalization. The STOXX Europe 600 is a broad measure of the European equity market, comprising a fixed number of 600 components across 17 countries and 11 industries within Europe’s developed economies. Past performance is not necessarily indicative nor a guarantee of future performance. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

P/E multiple re-rating

Japanese equities have traded at a significant discount to global peers for the better part of the past three decades. The relatively flat long-term growth outlook and sub-par ROE due to a lack of focus on shareholder interests contributed to causing this long-term discount.

The regime changes of economic normalization and corporate reforms in Japan are challenging this long- held understanding of the valuations of Japanese equities. As Japan’s nominal GDP growth and corporate ROE trend toward the levels of its global peers, a sustainable P/E multiple re-rating for Japanese equities is warranted, in our view.  

Conclusion: Favorable risk-reward, domestic focus

In 2026, EPS growth is likely to be the key driver for Japanese equity market returns. We see a favorable set-up for further upside from valuation multiple re-rating as global investors gain confidence in the regime changes in Japan. From our research, global investors remain underweight in their exposure to Japanese equities.

At TGI, our fundamental research is leading us to favor domestic-facing businesses. We believe this group of companies may be better positioned to benefit from Japan’s regime shifts. Banks and industrial companies are among the standouts. Japanese banks are likely beneficiaries of stronger loan demand and capital market activities, as the Japanese economy normalizes after 30 years of stagnation. The multiyear investment cycle among businesses also bodes well for industrial companies. 

We take a highly selective approach to foreign income earners, given the global economic and geopolitical uncertainties. We prefer companies with exposure to structurally growing end markets, such as semiconductors, electricity infrastructure and aerospace. Across both domestic and foreign-facing companies, progress in corporate reforms and commitment to shareholder interests will be key considerations. 

Endnotes

  1. Return on equity is the amount of net income returned as a percentage of shareholders equity, a measure of company profitability.
  2. Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock.
  3. Price to earnings is a stock’s (or index’s) price divided by its earnings per share, a measure of company valuation.
  4. “Animal spirits” is a term used by John Maynard Keynes in his 1936 publication, The General Theory of Employment, Interest and Money, which is used to describe human emotion that drives consumer confidence.

 

WHAT ARE THE RISKS?

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Equity securities are subject to price fluctuation and possible loss of principal.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

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