Nikkei Hits Record High: Political Shifts, Capital Awakening, and Tech Momentum

Former Prime Minister Shigeru Ishiba announced his resignation, plunging Japanese politics back into uncertainty. Yet, instead of scaring investors off, the political shake-up sparked fresh momentum. The Nikkei 225 broke through 44,000, repeatedly setting new highs. What’s driving this rally? And is it built to last?

Political shifts fuel easing expectations

The biggest catalyst has been the political transition and the policy expectations it brings. Within the LDP, Sanae Takaichi has emerged as the frontrunner, advocating stronger fiscal stimulus, tougher national defense, and a clear stance against premature rate hikes. For investors, that spells a friendlier policy backdrop. If she takes office, defense, energy, and exporters are likely to be the biggest winners.

Even if rival contender Shinjiro Koizumi prevails, markets see little downside. Known for his moderate, steady approach, Koizumi is expected to help maintain a stable upward pace for equities. In other words, whichever way the leadership contest goes, investors are buying into the story of policy support from Japan’s next leader.

Global easing and trade relief buoy risk assets

As an index heavily influenced by international flows, the Nikkei’s trajectory is tightly linked to U.S. monetary policy. The Fed is widely expected to cut rates by 25 bps at its September meeting, with softer August PPI even giving markets about a 10% chance of a larger 50 bps move. A looser U.S. policy stance doesn’t just benefit Wall Street - it also lifts global risk sentiment, Japan included.

Trade has been another tailwind. Progress on Japan-U.S. trade disputes has strengthened confidence, with Japan’s chief tariff negotiator announcing that Washington will lower auto tariffs by September 16, clearing a lingering hurdle from the July deal.

For an export-heavy economy, that’s a direct boost to autos and semiconductors, while also lifting manufacturing confidence. Indeed, the September Tankan survey shows Japanese manufacturers’ sentiment hitting its highest level since 2022. Reduced trade uncertainty has become a safety net for the market.

Recovery and capital inflows: the mid-term backbone

While politics and global easing are short-term sparks, the real backbone behind the Nikkei’s 46% surge since April has been Japan’s economic resilience. Q2 GDP expanded at an annualized 2.2%, more than double the 1.0% forecast, with both domestic demand and exports contributing.

The weaker yen has played a dual role: boosting export competitiveness while making Japanese assets look cheaper for foreign investors. In August alone, overseas investors net bought nearly ¥3.5 trillion in Japanese equities and about ¥4.2 trillion in bonds.

Domestic flows are also coming alive. With new tax incentives for investment, Japanese households — sitting on over $14 trillion in financial assets, half of it in cash and deposits — are starting to shift. Inflation has eroded real returns on savings, while wages are seeing their first meaningful growth in three decades, lifting disposable income.

This mix is encouraging households to move some funds from savings into equities. For the Nikkei, these domestic inflows provide long-term “sticky money” that not only deepens liquidity but also cushions the market against external shocks.

Tech momentum: Japan Is Becoming the “Third Option”

Another powerful driver has been tech - particularly AI and semiconductors. Japan boasts a strong ecosystem spanning design, manufacturing, and applications, making it a standout as global investors seek alternatives beyond the U.S. and China.

SoftBank is a case in point, swinging back to profit in Q1 with bold AI bets, including equity in OpenAI and the Stargate data center project. Sony, meanwhile, lifted its full-year guidance on robust quarterly results, reinforcing confidence in the sector’s earnings resilience.

For investors seeking tech exposure, both the U.S. and China carry hurdles. U.S. valuations are stretched, and monetary policy remains uncertain. China faces trade frictions and tighter domestic financing conditions. Against that backdrop, Japan’s open market, stable policy environment, and mature tech supply chain give it an edge as a “third pillar” in global tech investing.

Opportunities vs. Risks: Reforms Clash with Policy Uncertainty

The Nikkei’s rally isn’t being driven by a single factor - it’s the convergence of short-term policy shifts, mid-term economic recovery, and longer-term reforms. With earnings expectations improving, buybacks and shareholder return gathering pace, investors are shifting from chasing themes to focusing on fundamental value. If reforms can materially lift ROE, Japan’s equity re-rating still has room to run.

That said, risks remain. High valuations and crowded positioning make the market vulnerable to sharp corrections on bad news. And while strong GDP growth and a weaker yen have boosted exports, a shrinking current account surplus points to higher import costs and inflation risks - tensions between external optimism and domestic constraints haven’t gone away.

Politics is another wildcard. The LDP’s leadership race kicks off on September 22, with voting on October 4. A drawn-out or divisive contest could quickly add volatility.

On monetary policy, while the BOJ has already met its conditions for a hike - wages and inflation - and hinted at possible action later this year, it’s likely to stay cautious near term, which supports equities. Still, if policy turns more hawkish and the yen strengthens sharply, exporters could come under pressure.

In my view, Japanese equities remain an appealing medium-term story. Moderate gains by year-end seem likely, but the real potential lies in the next 12 months, when structural reforms and foreign inflows could push the Nikkei higher still. The rally has legs - but the ride will be bumpy in a world full of uncertainty.