Can Japan Flip the Script from Deflation to Domination?

Join Elizaveta Gridneva and Nicholas Ng on the IBKR Podcast as they explore Japan’s bold economic shift from decades of deflation toward growth and innovation. Discover whether structural reforms, BOJ rate moves, and global megatrends can flip the script for investors.

Summary – IBKR Podcasts Ep. 319

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Elizaveta Gridneva 

Hi everyone. Welcome to IBKR Podcast. My name is Elizaveta Gridneva. Tonight we’ll talk about Japan with Nicholas Ng, Head of APAC from Diver Asset Management. Hi Nick. 

Nicholas Ng 

Hi Liza. Thank you for having me on this episode. 

Elizaveta Gridneva 

Thank you for joining. So, big changes in Japan tonight. Kechi became the first Prime Minister in Japan’s history, which was accepted very well by stock markets and also by people in Japan. Expectations are high. She’s expected to increase government spending, ease inflation pressures, and improve life for ordinary people. So, first question for you tonight, Nick. Do you think she can deliver promises given before elections? What is your outlook in general for the Japanese economy under her leadership? 

Nicholas Ng 

Yeah, thank you very much for the question. I think generally, when it comes to elections globally, politicians tend to overpromise and underdeliver. However, in this case, and given the culture in Japan, from the outset it does appear that she should be able to deliver most of her promises. It’s interesting to note: the previous LDP leadership had a minority, so typically when they were looking to implement any policies, they may face some hurdles. However, now that she’s won the majority, it should theoretically be a lot easier for her to get her policies through. So I think, in short, she should be able to achieve most of her promises. 

Elizaveta Gridneva 

That’s great. And next, I think I would like to ask you about rates in Japan. So, Bank of Japan kept rates unchanged in the October meeting. There is expectation that it’ll hike in December. Is that also your expectation? And do you expect Bank of Japan will continue the rate normalization process next year too? 

Nicholas Ng 

Yeah. In terms of interest rates in Japan, our house view is the BOJ may hike one more time this year, so that would be in December. However, looking at the overnight index swaps market, it seems that the highest probability of a rate hike will likely be in January 2026. From the previous BOJ meeting, they were still concerned about the impact of tariffs and how that may impact the Japanese economy. So they’re still watching what’s happening. But yeah, it’s likely to happen in January 2026. 

Elizaveta Gridneva 

Understood. And just taking one step back—Japan looks to be on investors’ radar for the last few years. Historically, why do you think investors did not pay much attention to Japan? 

Nicholas Ng 

Yeah, I mean, historically investors haven’t really paid much attention to Japan, just given that the economy has been in deflation for the last two to three decades. And given that the economy has been in deflation, it just meant there hasn’t been much growth, if any—whether it’s economic growth or corporate earnings growth. And I think that’s why investors haven’t paid too much attention. If many investors aren’t paying much attention, they may think of Japan stuck in the 1990s or early 2000s, and they may only think about a Sony Walkman or a Sony Discman. They may think about household appliances from Sony or Hitachi—that could be like a fridge or microwave or TV—and autos, for example, just cars. 

It’s interesting to note: when it comes to equity investing, when you look at the MSCI All Country World Index, which is a global equity benchmark, the U.S. makes up the highest country weighting at around 63%. And surprisingly, Japan makes up the second-largest weight at close to 5%. So when equity investors around the world allocate to Japan, a lot of equity investors tend to be underweight Japan. And that’s slowly changing, where investors will start to allocate to Japan and, over time, be equal weight and start going overweight to Japan going forward. 

Elizaveta Gridneva 

Yeah, that’s an interesting fact to know. So you’re thinking that it’ll change. What’s the reason behind why people are finally interested in Japan now? What has changed? And I think our listeners would like to know what are some of the structural drivers supporting the economy and stock market? 

Nicholas Ng 

Yeah, sure. So in terms of the changes, I think there are probably three to four reasons, or the biggest drivers to why the economy is changing. The first one is normalization, or interest rate normalization from the BOJ, given that inflation has started to pick up in the last couple of years. This has obviously meant interest rates should also increase. And Japan has exited decades of deflation to move into inflation. So I think this is one of the biggest drivers. 

The next area is the Nippon Individual Savings Account, or NISA for short. In Japan, this NISA account acts like a tax-free savings account similar to the Roth IRA in the U.S. or the ISA in the U.K. And it is interesting to note for Japan: around 50% of households have their cash or investments in cash. And as interest rates start to rise, obviously they need to start moving their cash into risk assets. So when money flows into these NISA accounts, which are tax-free accounts, the money tends to flow into Japanese stocks and mutual funds as well as global investments. So I think that’s another driver. And I think the third driver is corporate reforms. Given that Japan has been in deflation or a deflationary environment for so long, a lot of corporates have been hoarding cash and haven’t really been spending on capital expenditure (CapEx) and growth projects. So they’ve been hoarding a lot of cash on their balance sheets. What this does is it makes the valuations a lot lower than what they theoretically should be, and their price-to-book ratios or return on equities may be artificially depressed. 

Now, the Japan Stock Exchange has said over the last couple of years that if your company listed on the stock exchange is trading at less than one times price-to-book ratio or a low return on equity multiple, there is a potential that we will delist your company. And obviously a lot of these companies don’t want to be delisted. So they have two potential options: 

1. They can potentially buy back their own shares with that cash on their balance sheet. With that cash, it’s essentially buying back their own shares—less shares outstanding—the stock price theoretically should go up. 

2. They can pay a higher dividend, which is good for shareholders, or a combination of both. 

So these are some of the structural drivers. And just lastly is the unwinding of cross-shareholdings. In Japan, cross-shareholdings is a relatively unique practice versus the rest of the world. This essentially means that a company—for example, let’s just take a bank—takes a stake in an auto manufacturing company. And the reason why they would do this is because it’s a soft way to cross-sell their products. So, for example, the bank may be able to cross-sell their loan products to the auto company. But also it’s for the corporate management team of the bank as well as the auto company to work together and protect their own interests from external shareholders. Given that cross-shareholdings are starting to unwind, it just means, for example, in this example, the bank is unwinding their shareholdings and selling their stake. They can use that cash for something more efficient and more productive. So there are a bunch of reasons why Japan has been gaining more interest from investors recently. 

Elizaveta Gridneva 

That’s great. Thank you for the detailed answer about the structural changes. So, what are the main investment themes currently in Japan and what should investors pay attention to in the future? 

Nicholas Ng 

In terms of investment themes, I think we could probably break it out into three areas. The first area is going to be structural reforms similar to what I shared earlier. So investment themes could be interest rate or BOJ normalization, where as interest rates rise, banks and financials tend to do well. It could also be corporate reforms and, you know, low-valuation companies will do well when they buy back their own shares or have dividend hikes. Another area is global megatrends. And when it comes to global megatrends, this could be, for example, the AI sector. So there are some companies within Japan that also benefit from the AI sector. That also includes defense—given that global defense stocks around the world have done very well over the last few quarters, Japan also has interesting defense manufacturing companies. And also autos and robotics and automation. 

I think the last area or themes which are of interest to investors could also be unique plays or themes to Japan. So this could be, for example, entertainment and intellectual property. Japan is known for games and anime. It could also be Warren Buffett’s favorite trading houses, which a lot of investors tend to look at. And just one more thing to add on what else investors should look at for Japan: typically, when investors look at Japan, Japan tends to be a fundamentally driven market as well as a style-driven market. Every market around the world is slightly different. For example, if you’re in the U.S. or Europe, generally the stock market is fundamentally driven. Whereas if you’re looking at Hong Kong or China markets, the equity market may be driven by news or macro sentiment, which drives equity prices. For Japan, it feels as if style tends to be one of the biggest drivers. 

And you might be wondering what do I mean by style? Style could be value names—companies that trade at low valuations—or growth names, companies with high earnings growth. The reason why style is important in Japan is because Japan has a fair amount of large-cap exporters. These are essentially companies that export their products globally. You could think of Sony or Hitachi or Toyota. If the Japanese yen weakens over time, when these companies sell their products overseas and bring their money back to Japan, obviously these companies will have higher profits. Conversely, if the Japanese yen strengthens when these companies bring their money back to Japan, it would be less. So movements in the U.S. dollar/JPY exchange rate impact style quite a lot within Japan. When investors do look at Japan, it’s important to look at U.S. interest rates as well as interest rates within Japan because currently we are in a value market in Japan, and we’ve been in this market for the last five years. But prior to that, we were in a growth market, which lasted for about four years. So the cycles do change. What’s really been driving this value cycle in Japan for the last few years is not just structural reforms in Japan, but also interest rate hikes in the U.S. And I think when this started in 2020, this has really fueled the value market. So theoretically, if U.S. interest rates trend lower over the next few years, then the growth market should come back. 

However, one big difference today is that Japanese interest rates are not pinned to zero and are able to freely fluctuate, which may ensure that the cycle is not 100% the same as the previous cycles. 

Elizaveta Gridneva 

Thank you, Nick, for this overview. And now moving on to some practical applications. For example, if someone is new to investing in Japan, what are some simple strategies to gain exposure to the Japanese market? 

Nicholas Ng 

Typically, for new investors looking to invest into Japan, the most common and easiest way is to invest into an index or an ETF. These usually are the TOPIX ETF or index, or it could be the Nikkei 225 ETF because this just gives you broad market exposure without having to know too much about the underlying stocks. Another way to invest into Japan is you can simply buy your favorite stocks. When it comes to foreign investors, including myself, most foreign investors tend to invest into large-cap exporters. They may also invest into blue-chip names, which they see on TV quite often. Or they may even copy trade Warren Buffett’s favorite five trading houses, which seems to be one of the most popular trades over the last couple of years. 

In addition, investors also invest through active funds. The reason why some people may invest into active funds is they think the active fund could potentially outperform the index. So a practical way to do it is if your view is the value cycle will continue, you would probably invest into an active value fund to ensure that you could gain some sort of alpha or performance advantage over a typical index. 

Conversely, if one’s view was that they thought we were late into the value cycle and may rotate into a growth cycle, then you may position into growth to play that bet. However, selecting a style in Japan is not always easy as it’s difficult to time. So what many investors do is they look for a blended or style-agnostic approach. This ensures they wouldn’t be caught off guard in case the style moved against them and they still wanted some potential upside or performance advantage over a typical index in Japan. So these are the most common ways that investors will gain exposure to Japan. 

Elizaveta Gridneva 

Thank you. That’s very insightful. And if we speak about some more sophisticated strategies, do you have any unique insights for us? 

Nicholas Ng 

Sure. Yeah. So, just adding onto the typical strategies which I mentioned earlier. Nowadays, investment managers and fund managers are becoming more sophisticated, and there are a few interesting ways or strategies that fund managers gain exposure to the market. One way is through a systematic or quantitative approach, which has been gaining popularity globally. This is essentially where a fund manager would invest into Japan following a quantitative or systematic screening model. It could be rules-based. It could be a multi-factor model where they would use quantitative metrics to determine the stock selection and the weights every month or every quarter with minimal human interaction. 

The second way is through a hedge fund-style strategy. This has started to gain quite a bit of popularity recently, just given that equity markets are at relatively high levels and investors like these types of strategies because if there is some sort of downside, the downside for a hedge fund strategy may be slightly less, but they’re still able to capture some sort of upside gain. Usually, this is for a long-short strategy or a market-neutral strategy where the fund manager will be long single stocks and also short single stocks, known as pair trades. It’s one way to lower the volatility or potential drawdown but still capture some of the upside. 

And the third way, which we’ve been hearing a lot more about recently, are activist strategies, otherwise known as engagement strategies in Japan. Your typical long-only strategy in Japan is usually when a fund manager would buy a stock and wait for the corporate management team to do something. With an engagement strategy or an activist strategy, the fund manager would essentially identify, for example, an underperforming company. They would strategize a potential solution, propose that solution to the corporate management team, and then see if they’re able to work with that corporate management team over the next few years to improve shareholder value and increase shareholder returns into the medium to long term. This strategy tends to have lower downside because the underlying companies have been poorly performing or mismanaged, so the fund manager feels that they may be able to potentially add value. So these are some more sophisticated strategies which investors have been looking at today. 

Elizaveta Gridneva 

Thank you. That’s great Japan with you. 

Nicholas Ng 

Thank you very much for having me, and I look forward to joining another episode in the future.