The spectacular rally in Japanese equities appears to be over after many years of strong gains. Following years of underweight positioning, global investors have finally turned their attention to Japanese stocks, spurred by a recent aversion to U.S. equities—just as momentum is beginning to fade.
While the Nikkei surged from 8,500 points in 2012 to over 42,000—a performance that even outpaced American markets—Japan is now facing a perfect storm of negative developments that may cause investors to lose confidence in Japanese equities. For those who believed Japan’s economic renaissance was unstoppable, a painful confrontation with reality is now unfolding.
The golden age of Abenomics
The story began with great promise. In December 2012, Shinzo Abe returned as prime minister of a country that had struggled for two decades with economic stagnation, deflation, and a rapidly aging population. Japan, once the economic marvel of the 1980s, had become what economists referred to as “the lost decades.” Abe’s response was ambitious: an economic revitalization strategy that quickly became known as Abenomics.
Inspired by the 16th-century tale of warlord Mōri Motonari, who taught his sons that three arrows together were unbreakable while each alone was vulnerable, Abe structured his strategy around three policy “arrows.” The first was aggressive monetary easing by the Bank of Japan, aimed at ending deflation and achieving two percent inflation. The second involved flexible fiscal stimulus through increased government spending. The third and most ambitious arrow targeted structural reforms: deregulation, increased female labor participation, corporate governance reforms, and expanded free trade agreements.
The results were spectacular. Thanks to a weak yen, ultra-low interest rates, and corporate governance reforms, Japanese corporate profit growth tripled since 2012—significantly outperforming the doubling seen among global peers. Japan finally managed to banish deflation after more than three decades. Annual “Shunto” wage negotiations showed spectacular increases for the first time in decades. Inflation is now at risk of overshooting.
The arrows are falling one by one
The foundations of this success are now crumbling. The weak yen, which benefited Japanese exporters for years by moving from around 100 to 160 per euro, is now strengthening, creating room for interest rate normalization. Ultra-low interest rates are rising toward more normal levels. And the corporate governance reforms have already harvested the low-hanging fruit. While cross-shareholdings between companies declined from 13.5 percent in 2015 to 8.4 percent, and activist investor campaigns have quintupled, the easy gains have largely been made.
Return on equity at Japanese companies has stopped rising, mergers and acquisitions are declining, and investor enthusiasm for structural reforms has faded. After years of positive momentum, Japan is now facing a string of negative shocks.
Trump’s tariffs
As if a stronger yen and rising interest burdens weren’t enough, President Trump’s protectionist agenda adds fuel to the fire. With tariffs of 25 percent on cars and auto parts starting in April 2025, Japan’s export-driven economy is set to take a hit. In 2024, car exports to the U.S. totaled six trillion yen—about 40 billion dollars and 28.3 percent of Japan’s total exports to that country.
The numbers speak for themselves: Japanese exports declined in May for the first time in eight months, falling 1.7 percent year over year. Exports to the U.S. plunged by 11.1 percent, driven by weakness in cars, auto parts, and semiconductor manufacturing equipment. Japan’s trade surplus with the U.S. shrank by 4.7 percent—the first decline in five months.
Japanese automakers are trying to offset tariff pressure with steep price cuts. Export value declined faster than volume, suggesting that companies are slashing prices significantly to absorb the higher costs. This is putting further pressure on their margins. According to the Japan Research Institute, domestic car production could fall by 4.3 percent if the 25 percent tariffs are fully implemented.
Prime Minister Shigeru Ishiba’s attempts to secure an exemption for Japan from the tariffs have so far been unsuccessful. Trade Minister Yoji Muto returned empty-handed from Washington earlier this month. The prime minister maintains that Japan is “considering all possible options,” but this sounds more like desperation than strength.
Inflation is no longer a friend
Paradoxically, Japan is now grappling with the “problem” of rising inflation—something the country had sought for decades. But timing is everything: in May, core inflation rose to 3.7 percent, above the expected 3.6 percent. This puts pressure on the Bank of Japan to raise rates further. The situation is especially challenging because food prices, excluding fresh products, rose by 6.9 percent, with rice prices skyrocketing by nearly 94 percent. For companies whose debt has swelled to 120 percent of GDP—far higher than the U.S. ratio of 75 percent—this represents a heavy financial burden.
The Bank of Japan is already signaling the possibility of additional rate hikes, possibly as early as July, according to economists. BOJ Governor Kazuo Ueda warned this week of “a new round of supply shocks in the form of food price increases.” This adds extra pressure on corporate profits already hit by the trade war and currency stabilization. The Japanese yield curve has returned to levels near the historical average, which also means the outperformance of Japanese banks is largely behind us.
A message to investors
The message to investors is clear: the favorable tailwinds that propelled Japan for years have turned into headwinds. The combination of a stronger yen, rising interest rates, increasing energy prices, American protectionism, and exhausted reform momentum is creating a perfect storm for Japanese corporate earnings. The tariffs, together with the stronger yen and higher interest costs, make Japanese equities far less attractive.
Economists warn that Japan may be heading into a technical recession in the second quarter—defined as two consecutive quarters of contraction. This would place the Bank of Japan in an even more difficult position as it considers further rate hikes. The Japanese miracle has run its course—the three arrows of Abenomics have been broken. It’s time to look elsewhere for growth.
Han Dieperink is Chief Investment Officer at Auréus Investment Management. He previously served as Chief Investment Officer at Rabobank and Schretlen & Co.