By Craig Mellow

Japan sustained a one-two punch in late July. The perennially governing Liberal Democratic Party lost its majority in parliament's upper house, throwing politics into turmoil. Three days later, the U.S. imposed 15% tariffs on exports that exceed 3% of Japanese gross domestic product.

Investors reacted...positively. The iShares MSCI Japan exchange-traded fund has climbed 9% since the trade deal with Washington was announced on July 23, consolidating a 20% gain year to date.

Job prospects for Shigeru Ishiba, the prime minister who led the LDP to a third straight election debacle, are looking up, too. "The likelihood of Ishiba surviving this political crisis has increased," says Tobias Harris, founder of consultant Japan Foresight.

The 15% levy could spell relative advantage for automobiles, Japan's No. 1 export to the U.S., notes Drew Edwards, head of Japan value equities at GMO. "With U.S. auto makers paying 50% tariffs on imported steel, the Japanese may stand to pick up market share," he says.

Further gains in Japanese stocks could come harder. "The latest rally has taken us to our limit on Japan," says Alex Wolf, head of macro investment strategy at J.P. Morgan Private Bank.

Other managers are shifting focus from industrial heavyweights to domestic-facing stocks, particularly financials. Monetary conditions are favorable for Japanese banks, argues Daniel Hurley, a portfolio specialist in international equities at T. Rowe Price. The Bank of Japan is holding its prime rate at 0.5%, while the yield curve for longer-term borrowing tips sharply upward, offering generous interest margins. His picks in the sector include Mitsubishi UFJ Financial Group and Resona Holdings, a regional player based in Osaka.

The yen could appreciate sharply in the medium term, adds Aaron Hurd, senior currency portfolio manager at State Street Global Advisors. Japanese interest rates should inch up while the Federal Reserve cuts and U.S. growth slows, reducing the pull of U.S. assets. The yen, currently at 147 to the dollar, "will be in the low-130s by the end of next year and 120s after that," Hurd predicts.

A stronger currency would depress earnings for global manufacturers like Toyota Motor and Sony Group, but spell relief and looser wallets for consumers coming to grips with Japan's first inflation in decades. "Japanese authorities will be pretty happy with a stronger yen," Hurd expects.

The LDP's electoral defeat, and need to entice new coalition partners, increases chances for some crowd-pleasing fiscal stimulus that could juice consumer spending in the meantime, Edwards says. "I wouldn't be surprised to see some populist measures like a cut in taxes on fuels," he says.

He is focusing on healthcare stocks, which have a surprisingly low weighting in the world's oldest country. Picks include surgical supplier HOGY Medical and laboratory network H.U. Group Holdings.

A longer-range tailwind for Japanese stocks remains a governance sea change toward returning more capital to shareholders and reducing the deadweight of cross-shareholdings. Share buybacks jumped by more than half last year to $108 billion, according to Nikkei Asia. "Investors expect Japanese companies to allocate more money to active investments and shareholder returns," says Kazunori Ito, director of Japanese equity research at Morningstar.

Japan cannot escape being a trade-reliant nation in a trade-war era. Exports have exceeded 20% of GDP for the past few years, twice the U.S. proportion. Other strengths are keeping some investors hopeful, though. "Japan remains the most overweight position in our portfolio," GMO's Edwards says.

Email: editors@barrons.com

To subscribe to Barron's, visit http://www.barrons.com/subscribe

(END) Dow Jones Newswires

August 22, 2025 21:31 ET (01:31 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.