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.
Contrary to concerns that a large mandate would embolden populist spending, the scale of Prime Minister Takechi's victory provides political security. This reduces the perceived need for drastic measures like a promised consumption tax cut, reassuring investors in the FX and rates markets about fiscal discipline.
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.
Following a historic election victory, the winning prime minister becomes personally associated with the pro-growth policies driving the market. Consequently, the biggest risk to the current rally is not economic but political: an unexpected resignation could abruptly end the cycle, as seen historically in 2006 with Prime Minister Koizumi.
When Japanese equities outperform U.S. markets on a dollar-adjusted basis, it triggers a "geographic diversification trade." This attracts a new wave of foreign investors, particularly from the U.S., whose capital inflows then push Japanese stock prices and multiples even higher, creating a positive feedback loop.