By Craig Mellow

Japan is sailing into headwinds that could turn to gale force. Stocks keep outperforming anyway. The iShares MSCI Japan exchange-traded fund is up 10% this year, while the S&P 500 is flat.

Investors might want to take some profit, at least until they have more clarity on a trade deal with President Donald Trump. Japan's economy stopped growing last year as Prime Minister Shigeru Ishiba's government pared back spending to control world-beating sovereign debt levels. The U.S. trade offensive won't help.

On the domestic front, Ishiba's Liberal Democratic Party will likely lose seats in July 20 elections for parliament's upper house, threatening an already wobbly governing coalition. A doubling of rice prices over the past year, with Soviet Bloc-esque lines forming for subsidized grain, speaks to severe teething pains from the economy's long-awaited thrust from deflation to inflation.

A return to economic expansion will come next year at best, says Masamichi Adachi, chief Japan economist at UBS. "We forecast a technical recession for the second half of 2025," he says.

While other U.S. trading partners scramble to head off "reciprocal tariffs" ahead of a putative July 8 deadline, a 25% levy on auto imports from Japan is already in effect. Japan shipped 1.6 million cars across the Pacific last year worth about $40 billion, or 1% of gross domestic product.

Given autos' emotional resonance, Tokyo stands little chance of reprieve, thinks Shigeto Nagai, head of Japan economics at Oxford Economics.

"We will never go back to the world before Liberation Day," he says. "That will be a very significant problem for Japan."

Ishiba does have carrots to offer Trump -- Japanese investment in U.S. shipbuilding, purchases of weapons and liquefied natural gas -- says Wendy Cutler, a veteran U.S. trade official now vice president at the Asia Society Policy Institute. But pending elections may make the Japanese leader less pliant. "Ishiba doesn't want to bring home a deal that looks weak," she says.

The rice crisis points up the gulf between old and new Japan, literally and figuratively. "Some 90% of rice growers are over 60 and have no successors," Nagai notes. Loyal LDP voters, farmers have kept their market protected and distribution locked up by semiofficial cooperatives, whose missteps fueled recent shortages.

Older citizens in the world's oldest nation are generally suffering as pensions lag behind the newfangled inflation, currently above 3% annually, UBS' Adachi adds.

The good news is that wages for the working-age may be going up faster than prices. "The younger generation under 40 is benefiting," Adachi says.

The breakout from three decades of deflation is "awakening entrepreneurial spirits" across Japanese society, argues Daniel Hurley, a portfolio specialist in international equities at T. Rowe Price. "Inflation forces both corporates and savers to invest, not just sit on cash," he says.

The brightest bull indicator, though, is Japan Inc.'s mounting enthusiasm for share buybacks, the latest front in a campaign to become more shareholder-friendly.

Marquee names like Sony Group, Mitsubishi, and Hitachi have committed to repurchasing 10% of outstanding equity over the next fiscal year, Hurley notes. "There's a lot of noise around the elections and trade talks, but we remain very constructive on Japan," he says.

Nonetheless, T. Rowe is looking to "sell the cyclical exporters" that dominate the market index, shifting into defensive domestic-facing stocks "more toward the mid-cap end of things."

Less committed investors might just want to wait until the noise quiets down.

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(END) Dow Jones Newswires

June 27, 2025 21:31 ET (01:31 GMT)

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