Tokyo Stocks Target New Highs in 2026 Amid Yen Crisis Fears

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Tokyo Stocks Eye New Record Highs in 2024

Tokyo stocks are expected to continue their upward trend next year, aiming to reach new record highs. This optimism is fueled by the government’s expansionary stimulus measures, which are anticipated to boost corporate earnings. Analysts believe that the positive momentum will be driven by several key factors, including advancements in artificial intelligence (AI) and a reduction in the impact of U.S. tariffs on the auto industry.

One of the main concerns for investors is the performance of the 10-year Japanese government bond. While yields above 2.0 percent may not significantly affect equities, there is a risk of excessive yen weakness against the U.S. dollar. This weakness is linked to fears about Japan's deteriorating fiscal health, which could pose a downside risk to the market.

The benchmark Nikkei Stock Average is projected to climb toward 55,000, surpassing its previous all-time closing high of 52,411.34 reached in October. This growth is expected to be driven by continued development in the AI sector and the easing of U.S. tariffs on the auto industry.

Experts suggest that the aggressive fiscal policy of Prime Minister Sanae Takaichi, who took office in October, will remain a significant driver of market growth. The focus on critical industries such as AI, semiconductors, and shipbuilding is expected to benefit from increased government investment.

Maki Sawada, a strategist at Nomura Securities Co., noted that policy effects are likely to drive economic growth, with prices continuing to rise. A positive cycle involving wage increases could further support corporate earnings.

Automakers are also expected to see an improvement in earnings as the negative impact of U.S. tariffs imposed by former President Donald Trump is anticipated to be less severe than previously thought. A bilateral accord in July to reduce the tariff rate has contributed to this outlook.

Masahiro Yamaguchi, head of investment research at SMBC Trust Bank, highlighted that auto and other exporters were particularly affected by the Trump tariffs this year. However, he believes that companies struggling with sluggish earnings can expect a rebound next year. He added that if auto shares perform well, it would support the overall market.

Despite these positive expectations, a further depreciation of the yen past 160 versus the dollar is seen as a potential downside risk. This could accelerate inflation by increasing import costs and potentially dent the popularity of the Takaichi government, which currently enjoys high approval ratings.

The yen has remained weak, mostly above 150, despite interest rate hikes by the Bank of Japan and monetary easing by the U.S. Federal Reserve. Takuya Kanda, senior researcher at the Gaitame.com Research Institute, noted that while the interest rate differential between Japan and the U.S. is expected to narrow, it may not be the decisive factor for the exchange rate. The flow of yen selling for both investment and non-investment purposes is likely to continue.

Concerns about Japan's fiscal soundness under Takaichi are also contributing to the yen's decline. Rising long-term Japanese interest rates have not prevented the currency's drop, according to dealers. Kanda added that a general election next year, if the Liberal Democratic Party under Takaichi scores a landslide victory, could also act as a yen-selling incentive.

A sharp yen slide could increase the cost of living for households already facing higher prices for food and daily necessities, potentially dampening consumer spending. Chisa Kobayashi, a strategist at UBS SuMi Trust Wealth Management Co., warned that if inflation continues to rise, wages may not increase in real terms even if companies raise salaries. This could lead to falling support for the government.

Analysts believe that the adverse impact of higher government bond yields on stocks is likely to be limited unless they jump above 2.5 percent in the short term. The key government bond yield surpassed 2.0 percent when the BOJ raised its policy rate to a 30-year high of around 0.75 percent on Dec. 19. It continued to rise, hitting 2.100 percent in the following week, its highest level since 1999.

Yamaguchi noted that the Japanese market differs from the U.S., where growth stocks like tech issues visibly react to higher interest rates. He suggested that bank shares may benefit from higher yields. However, he cautioned that higher interest rates could negatively affect Japanese stocks if they cause an economic slump and start affecting fundamentals over time.

Another potential downside risk to the stock market is a possible setback in the AI industry. Concerns about returns on massive AI investments have previously caused technology and semiconductor stocks to decline. Masahiro Ichikawa, chief market strategist at Sumitomo Mitsui DS Asset Management Co., warned that if views spread that capital investment in data centers was excessive or profits were not meeting expectations, it could cause AI stocks to plunge and impact Japanese stocks as well.