Japan: Macro and geopolitics brew winners in industrials, IT and financials

Hoping that Japan will escape its prolonged economic underperformance that began in the early 1990s, global investors returned in late 2023. Shortly after, the Bank of Japan (BoJ) terminated its negative interest rate policy in March 2024, and nominal wages rose to their highest level in three decades. In this note, we analyze the prospects of Japan’s macroeconomic environment and market changes, followed by our projection of winning sectors amid the current geopolitical landscape.Japan in transition out of prolonged deflationWith the rebound in nominal wage growth, the BoJ terminated its negative interest rate policy in March 2024. The policy changes came against the backdrop of cost-push inflation driven by global inflation and higher energy prices, and more importantly, the virtuous cycle from income to spending. Such wage hikes have been driven by large firms which have substantially raised their labor productivity. Still, the wage increases for SMEs, which generate about 70% of employment, has been limited.Although the medium-term outlook has improved, the uncertainties rising from US President Trump on tariffs can pose challenges to Japan’s exports, which has faced headwinds so far in 2025. Private consumption is also suffering due to higher import prices, which has brought GDP growth lower than expected in the first quarter.These developments have complicated policy responses. The BoJ is keen to normalize to create room for rate cuts, but the scope has been narrowing. While a rate hike could strengthen the Yen appreciation could further hurt manufacturing. In addition, yields of Japanese Government Bonds (JGBs) have shot up as the market has begun to question fiscal discipline, with a weak result on the 40-year JGB auction on May 28th. Hence, the scope for a large fiscal response to stabilize the economy has been diminishing, as the public debt has remained at 250% of GDP.Market reform as a game changerDespite these challenges, the reform of Japan's corporate governance aims to improve capital efficiency, such as through initiatives to boost the price-to-book (P/B) ratio and return on equity (ROE). As a result, annual dividends and share buybacks have increased by 85% from 5.8 trillion yen in 2015-21 to 10.8 trillion yen in 2022-24. Finally, the total return from dividends and buybacks also grew from 3.1% to 3.5%.Japan’s sectoral differences: our picksWe find that industrials, information technology, and financials will see the most tailwinds driven by economic and geopolitical factors: a) macroeconomic drivers, such as interest rates; b) Japan’s sectoral focus on industrial policies and investment flows; c) the relative performance of Japanese and global firms with asset size larger than $10 billion on average in 2023-24 using financial statements.► Industrials: Higher return on capital supported by reform and specializationIn Japan, the industrial sector shows one of the highest returns on invested capital (ROIC), reaching 7.8% in 2023-24, compared to 6.8% in 2018-19. Notably, it is the only sector where Japan exhibits both a higher ROIC and lower leverage than its global peers. This improvement is attributed to proactive spin-offs of unproductive businesses and a focus on high-value manufacturing. While Japan cannot compete with China on price, its specialization strategies have proven indispensable to global supply chains, allowing it to maintain its role and profitability. Since 2018, when the first round of the trade war commenced, Japan has gained a larger global export market share within the high-complexity segment, especially in advanced machinery.► IT: Critical in upstream chipmaking with strong government supportRegarding information technology, Japan excels in the upstream semiconductor equipment and materials market, with market shares of 29% and 61% in 2024. As artificial intelligence fuels demand, government support is also yielding results. The Japanese government provided $27 billion, or 0.7% of GDP, in subsidies to the semiconductor industry from 2021 to 2023, a higher proportion than in other countries. In November 2024, Japanese Prime Minister Shigeru Ishiba announced the plan to further commit $65 billion or more by fiscal year 2030. On a three-year average basis, Japan's inward greenfield investment grew 61% from 9.8 billion yen in 2019 to 15.8 billion yen in 2023. The share of semiconductors has also increased from 1% to 62%.► Financials: Better loan growth and net interest marginsFor banks, better nominal growth and inflation have contributed to faster loan growth of 4.3% in 2022-24, higher than 2.9% in 2015-19, which helps expand the banks' interest-earning assets. As the BoJ hikes interest rates, this gives more room for banks to widen their net interest margins (NIM). Banks have also accelerated the pace of selling strategic shareholdings, which refers to non-controlling minority shares held not for investment purposes, but for other benefits such as building business relationships. As banks sell these shares, they will be revalued from book value to market value, thereby generating profits. Due to better loan growth, a more favorable interest rate environment, and the revaluation of strategic equity holdings, the net income of Japanese banks reached a new high in September 2024.Conclusion: Japan offers structural improvement and opportunitiesAlthough the world is more uncertain, Japan’s macro environment and global geopolitical shifts still bring sectoral opportunities. With product specialization in global supply chains, supportive government industrial policies, higher return on capital, and higher interest rates as tailwinds benefiting Japan’s industrials, IT, and financials the most. Still, Japan faces medium-term challenges including high government debt, low productivity in general, and a slow recovery in consumption. But this does not mean there are no selective and positive tactical opportunities.