Japan's current market conditions—a very weak currency, low front-end rates, and a steepening yield curve—are creating a potential macro inflection point. This setup is analogous to the 2014 US market, which preceded a major rally in the dollar and bonds, suggesting a compelling long yen and JGB trade.

Japan is experiencing a historic capital rotation. After decades of a bond-centric, "play not to lose" mentality that favored an aging population, the country is shifting capital into equities and other risk assets. This is driving its stock market to new highs and reflects a fundamental need to finance new growth industries.

Unlike the past, where economics dictated a strong yen despite loose policy, markets are now driven by politics. The Japanese government is allowing the yen to devalue to manage its debt, even as interest rates rise. This weakens the yen, strengthens the dollar, and could fuel a US equity boom via carry trades.

Despite Japanese stock indices more than doubling since 2022, the underlying Return on Equity (ROE) for the market has remained flat around 9-10%. The next phase of the rally is contingent not on sentiment, but on tangible ROE improvements driven by aggressive restructuring, M&A, and shareholder returns.

While many focus on Japanese equities, CIO Jack Abel highlights the currency as the most compelling opportunity. On a purchasing power parity basis (like the Big Mac Index), the yen is so undervalued that a dollar buys 3-4 times more in Japan, signaling a significant potential for reversion.

After decades of stagnation, Japan is experiencing a bullish turn. PIMCO's CEO attributes this to two key factors: the first real inflation in years and a surge in corporate activism. Activist investors are breaking up conglomerates and improving business models, making Japanese equities newly attractive.

Foreign inflows into Japanese equities are high, but the FX hedge ratio is only 14%, far below the 50% seen during the Abenomics period. J.P. Morgan estimates every 1% rise in this hedge ratio could push USD/JPY 3 yen higher, representing a significant and overlooked bearish catalyst for the yen.

Investors borrow Japanese Yen at low interest rates to buy high-growth assets like NVIDIA, pocketing the difference. When Japanese rates rise, these investors must sell their stocks to cover the debt, causing a cascade of selling pressure unrelated to the company's performance, revealing global market interconnectedness.

Following the last three LDP supermajority victories (2005, 2012, 2014), Japanese markets saw an average 20% gain in the first three months. This initial surge is followed by a multiple expansion over the next nine months, driven by expectations of political stability and increased foreign investment.