Japanese Stock Market: Market Outlook for 2026

■ With pressure to enhance corporate value and market acceptance of inflation, the price-to-earnings ratio (PER) is expected to rise overall.  

■ Attention should be paid to the long-term and deepening deterioration of Japan-China relations, as well as the environmental changes brought about by the end of the US interest rate cut cycle and the midterm elections. 
 
   The Nikkei average index showed a weak trend at the beginning of the year, but this situation reversed in April. Entering the second half of the year, the index turned upward and rose significantly to a higher range. Since the beginning of the year, the market has been generally weak due to repeated fluctuations in the US government's tariff policy; in April, the mutual tariffs were officially implemented, and China took retaliatory measures, causing the Nikkei average index to plummet from nearly 40,000 points at the beginning of the year to the 30,000-point range. Subsequently, the market gradually reached a consensus that the extreme policies proposed by the US government would ultimately be difficult to implement fully. Additionally, the agreement reached in the Japan-US tariff negotiations in late July led to the stock market turning upward and hitting a new historical high. After the establishment of the Takaichi government in October, market expectations for "responsible and proactive fiscal policy" heated up, and the imagination of expanding demand related to artificial intelligence (AI) centered on the US increased, boosting related domestic stocks, and the index once reached the 52,000-point range. Since November, market concerns about over-investment in AI-related fields have increased, with the index fluctuating around 50,000 points. However, as of the 26th, the year-to-date gain reached 27.2%, significantly higher than the US (S&P 500 at 17.8%) and Europe (STOXX Europe 600 at 16.0%). 
 
   As of the 26th, TOPIX's one-year forward P/E ratio was 15.5, approaching the upper limit of its range since 2013 (12–16 times), making the impression of overvaluation undeniable. However, pressure from the Tokyo Stock Exchange and investors to improve corporate value is gradually settling; simultaneously, with continued inflationary pressure from wage increases, TOPIX's forward ROE has risen from 9.3% at the beginning of the year to 9.7%, showing an upward trend. Correspondingly, the forward P/B ratio (PBR) has also increased (from 1.31 times to 1.51 times). With the rise in forward PBR, the range of forward PER is also expected to shift upward, potentially reaching as high as approximately 17 times. 

 
   The income growth effect brought about by inflation stabilization, profit margin improvements resulting from changes in corporate pricing behavior, performance expansion driven by wage increases boosting domestic demand, and uniquely positive factors for the Japanese stock market, such as mergers and acquisitions (M&A) and shareholder return policies, are expected to remain a focus next year. The government has approved the 2026 budget, with general accounting totals increasing by approximately 7 trillion yen year-on-year to 122.3 trillion yen, marking a record high for the second consecutive year. Sectors such as AI, semiconductor-related electrical and precision industries promoted by the Takaichi government, as well as machinery, steel, and non-ferrous metals sectors, including defense and nuclear power, are expected to benefit from a favorable environment. Market forecasts predict an EPS growth rate of 10.2% for the next year, with the Nikkei average potentially reaching 58,000 points and closing at 54,000 points by the end of the year. 

 
   The longer the deterioration in Japan-China relations persists, the more pronounced the negative impact will be on stocks related to inbound tourism and companies with a high proportion of sales to China; if the situation escalates to restrictions on rare earth exports, the entire supply chain, starting with automobile and home appliance manufacturers, will be impacted. Furthermore, expectations of expanding demand and over-investment related to AI will likely persist next year, potentially becoming a significant factor triggering substantial stock price volatility. By the second half of 2026, the end of the US interest rate cut cycle will gradually become apparent, and the risk of policy effects becoming less pronounced around the time of the US midterm elections will increase, necessitating caution regarding the possibility of weakening upward momentum in stock prices.