Japan's stock market has repeatedly reached new peaks, driven by renewed political confidence and the ruling party's economic agenda. However, experts warn that the market has become detached from the country’s underlying economic fundamentals.
The Nikkei 225 index recently set multiple records, breaking through the 56,000 and 57,000 thresholds and approaching 58,000. This rally has been largely fueled by what is referred to as the "Sanae Takaichi trade"—following her decisive victory in the House of Representatives election.
Although the market was closed on Wednesday for a holiday, the Nikkei had surged to a high of 57,960 points on Tuesday. Year-to-date, the index has gained approximately 15%.
Market observers indicate that political optimism has been a key pillar of the recent surge, with Takaichi’s strong electoral mandate sparking investor enthusiasm. Hopes are growing for expanded government spending, tax cuts, and a more aggressive economic agenda.
However, analysts caution that market enthusiasm has outpaced clarity on how these policies will be funded. They also note that Japan’s stock market is increasingly fragile, vulnerable to currency fluctuations, global shocks, and a widening gap between share prices and economic fundamentals.
Richard Harris, CEO of investment management firm Port Shelter, stated that the current gains are not supported by economic strength: "This isn't driven by fundamentals. Whether you look at exchange rate trends or economic performance… there's nothing particularly strong to justify this rally."
Data released by the Japanese government in November showed that the economy shrank by 0.4% in the three months to September, marking the first contraction in six quarters. On an annualized basis, the decline was 1.8%.
According to IMF data, Japan is the world's most indebted nation, with its debt-to-GDP ratio projected to approach 230% by 2025. Increased fiscal spending could further exacerbate this debt burden.
In November, the Japanese government approved a fiscal stimulus package exceeding $135 billion, which will likely require additional borrowing.
Harris noted that sentiment, liquidity, and market narratives are the main drivers of the current rally. "We’ve seen this in other markets as well," he added, pointing out that Japan’s record highs are part of a broader global enthusiasm for equities and AI-related investments.
**AI Influence and Yen Volatility**
Stefan Angrick, a senior economist at Moody’s, also believes that the artificial intelligence boom has lifted global stock markets, including Japan’s.
"The current situation appears somewhat fragile because valuations are being driven by global equity enthusiasm," Angrick said.
Japan’s high exposure to global manufacturing and capital goods makes it a key beneficiary of AI expansion. However, this linkage also makes the market highly sensitive to any cooling in global tech enthusiasm or shifts in exchange rates, which have quietly played a supportive role in the rally.
In recent months, this sensitivity has become more evident as concerns over an AI bubble have triggered volatility—including in Japanese stocks. Last week, AI firm Anthropic released new tools capable of handling complex professional workflows, services that are central to many software companies. This was followed by a sell-off in software-related stocks.
Angrick added that the yen is another factor contributing to market fragility. Over the past year, the yen has depreciated significantly, which typically benefits Japanese stocks given the large share of export-dependent manufacturers in the market.
A weaker yen boosts corporate earnings and elevates stock valuations, but this effect is likely to fade. "The yen has deviated substantially from fundamentals—it's simply too weak, unreasonably so," he remarked.
Data from the London Stock Exchange Group shows that the yen has depreciated by about 3.67% against the U.S. dollar over the past six months.
Japanese authorities have hinted at possible intervention if the yen continues to weaken. Finance Minister Satsuki Katayama has even expressed concerns to U.S. Treasury Secretary Scott Bessent about the yen’s "one-sided depreciation."
Aberdeen Investments expects the yen to appreciate as real interest rates gradually rise and inflation slows more than currently anticipated.
Angrick also anticipates a stronger yen. "The market expects the yen to appreciate over the medium term, which could lead to a moderation in equity valuations," he said, adding that exchange rate normalization could "trigger a significant correction in current stock prices."
That said, this does not necessarily mean Japan’s bull market has run out of steam.
Experts note that structural reforms implemented in recent years—particularly in corporate governance, capital efficiency, and shareholder returns—have provided sustainable growth momentum for the market. Encouraged by the Tokyo Stock Exchange, companies have increased share buybacks, unwound cross-shareholdings, and become more focused on return on equity.
Some asset managers believe that Japanese corporate fundamentals remain supportive overall, but only if expected reforms are fully implemented.
Zuhair Khan, a portfolio manager at Union Bancaire Privée, stated that as long as a strong and stable government maintains market confidence, the rally is "real." However, he warned that stock prices have already priced in reforms that have yet to materialize.
"The market has already factored in improvements that haven’t been realized," Khan said, citing expectations for asset sales, share buybacks, and margin improvements. This leaves little room for disappointment.
"If the pace of reform slows, there is downside risk," Khan cautioned.