Bernstein stays bullish on Japan stocks for H2, favors exporters

Bernstein analysts maintain an optimistic outlook on Japanese equities for H2 2025, citing structural reforms, a weak yen, and rising shareholder returns as key tailwinds attracting global investors. While domestic stocks are a long-term preference, exporters are expected to lead the near-term recovery driven by favorable currency dynamics, despite a recent earnings downgrade cycle. Foreign institutional investors have shown renewed interest with significant Q2 inflows, and Bernstein anticipates an earnings bottom soon, favoring quality and growth stocks for Q3 with value potentially rebounding later in the year.

Analysis

Bernstein analysts project an optimistic outlook for Japanese equities in the second half of 2025, underpinned by structural corporate governance reforms, a weak yen, and rising shareholder returns. These factors are attracting significant foreign capital, evidenced by a reversal from a $37 billion outflow in Q1 to a $44 billion inflow in Q2 from foreign institutional investors. The reforms have driven Return on Equity (ROE) to decade highs and spurred a surge in M&A activity. While domestic-focused stocks have outperformed exporters year-to-date (13.3% vs 12.2%), Bernstein anticipates a tactical shift where exporters will lead the near-term recovery due to favorable currency dynamics. Despite a sharp earnings downgrade cycle, an earnings bottom is expected soon, particularly in technology and energy. From a factor perspective, quality and growth stocks are positioned favorably for Q3, with a potential for value stocks to rebound later in the year if rate hikes are implemented. Specific sectors flagged with a bullish outlook include technology hardware, pharmaceuticals, and financials, while autos and healthcare equipment are noted to face headwinds.

Key Decisions for Investors

• Consider a tactical overweight on Japanese exporters, particularly in the technology hardware, pharmaceutical, and financial sectors, to capitalize on the weak yen and an anticipated earnings recovery.
• For the third quarter, a focus on quality and growth factors within a Japanese equity allocation is advised, while investors should prepare for a potential rotation into value stocks later in the year contingent on monetary policy tightening.
• Investors should maintain unhedged exposure to the Japanese yen when investing in the region's equities to fully capture the currency tailwind driving the positive outlook for exporters.
• Monitor the pace of corporate earnings downgrades as a key near-term risk, and track foreign institutional investor flows for confirmation that the positive sentiment is translating into sustained capital allocation.