Japanese Stocks Need This to Break Out

(KAZUHIRO NOGI/AFP via Getty Images)

The Japanese stock market is having a difficult time reaching new highs. It will have an easier time if U.S.-Japan trade relations improve soon.

The Nikkei 225 has dropped almost 4% to 40,290 from 41,826, in late July, a 2025 high. Since it first hit a record close in July 2024—at the 42,224 mark—the index has struggled to gain more traction. Every time it reaches the low 40,000 area, sellers come in to knock the index lower.

The good news is that the index isn’t in trouble. It remains on a larger uptrend that began in late 2022, as the Japanese economy and the index’s aggregate profits have grown. The government has implemented corporate governance reforms to increase companies’ financial disclosures and push management teams to return more cash to shareholders.

That’s why the Nikkei 225 has seen traders coming in to buy dips at higher levels—all above 36,000—since May. The signal is that market participants want Japanese stocks after brief dips as long as they believe the country’s economic fundamentals will remain strong. Still, something is holding those buyers back at current levels.

The elephant in the room is the state of trade relations. That’s especially important for the export-oriented Japan, which sold $148 billion of goods to the U.S. in 2024, according to the Office of the United States Trade Representative. Tariffs lift the cost of goods for the importer, reducing consumer and business demand in that country.

Japan exports just over $700 billion of goods yearly to many countries, according to FactSet, representing about 17% of total 2024 gross domestic product of almost $4.2 trillion. Looming over that are President Donald Trump’s tariffs on all countries, including Japan. Slower global demand would directly hurt Japan, which relies on exports to many nations to grow its economy.

Secure trade deals are crucial for Japan. Aug. 7 is the new date at which Trump’s revised tariff rates across the globe will take effect. Markets want to see that he sticks by those rates. Meanwhile, Japanese Prime Minister Shigeru Ishiba mentioned Monday that he wants to confirm with Trump that tariffs on automobiles sold into the U.S. will remain lower. Ishiba wants to avoid a written document, and instead keep a verbal agreement, so that the White House is less likely to delay the cuts.

Tariffs remaining in place would give Japanese investors more certainty, while any agreement to further cut them would of course boost Japan’s economic outlook. Right now, its economy is stable. Economists currently forecast 0.9% real GDP growth for this entire year, with their forecast for the coming two years averaging 0.9% growth, according to FactSet.

That will help push earnings higher, especially with economists projecting low single digit—and stable—inflation this year through 2027. That’s why analysts expect aggregate sales for Nikkei 225 companies to grow almost 4% annually through 2027 after this year. That could nudge profit margins higher. With continued share buybacks, annual earnings-per-share growth is expected at just over 10%.

The index could then set new highs, barring any major near-term setbacks for the Nikkei 225’s performance—especially if investors start paying a higher multiple on earnings. The index trades at just over 18 times expected earnings for the coming 12 months, a discount to the S&P 500 ’s 21.9 times. The two indexes have sometimes traded at par in the past five years. If Japan’s earnings story—and shareholder return picture—remains on track or improves, earnings multiples could rise.

“Japanese equities offer a unique combination of discounted valuations, ongoing corporate reform efforts and strong fundamental growth,” Glenmede’s chief of investment strategy, Jason Pride, wrote in a report. Pride highlights the Japanese market as one to own for U.S. investors who want to diversify their equity holdings and benefit from global growth.

The Nikkei 225 will break out soon. It’s likely only a matter of time.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com