Japan’s Renewed Revolving Door Turns Again

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Once upon a time, Japan wasn’t just the Land of the Rising Sun, but the Land of the Revolving Door. Like clockwork, prime ministers (PMs) would ascend, then vanish within a year. The late Shinzo Abe’s record-long tenure seemed to put that era to bed. But since he retired in 2020, turnover has increased. Now the revolving door is turning again: PM Fumio Kishida announced he won’t run in the Liberal Democratic Party’s (LDP’s) September leadership contest, which will give Japan its third PM since 2021. This may raise near-term uncertainty a bit, but we doubt it changes much for Japanese stocks. With a general election looming next year, politicians have little incentive to pass big bills. Politics will probably be more of a 2025-and-beyond factor for Japanese markets.

Kishida, who succeeded Yoshihide Suga in October 2021, has been on borrowed time since late 2023, when the LDP’s fundraising scandal broke. Though he wasn’t implicated, it felled several of his cabinet ministers and party luminaries—and spelled the end of the LDP’s traditional faction system. As the party’s poll numbers (and his cabinet’s approval rating) plunged amid public disgust with slush funds and other revelations, Kishida tried to stay above the fray and spearhead LDP reforms. But the changes, which converted factions from parties within the party (complete with their own fundraising and hierarchies) to loose policy groups, didn’t do much to soothe the public: The LDP got trounced in three by-elections in April.

Japan’s economy, which looked recessioney for the better part of the last year, hasn’t helped. GDP fell -4.0% annualized in Q3 2023, clawed back 0.3% in Q4, then sank -2.3% in Q1 2024.^[i] But even these figures are flattered by export growth, boosted by a weak yen that let firms reap big profits off currency translation. The yen’s weakness has done nothing to spur export demand, mind you. Despite reports hyping rising exports in value terms, export volumes fell in five of six reported months this year and tumbled -6.2% y/y in June.^[ii] Domestic demand, meanwhile, fell consecutively from Q2 2023 through Q1 2024 as the yen slammed households and domestic businesses with higher costs.^[iii] The BoJ’s rate hikes sought to help this, but Japanese stocks overreacted, losing -24.0% in 16 trading days, seemingly sealing Kishida’s fate.^[iv] It seems doubtful that Q2’s 3.1% annualized GDP growth and domestic demand recovery—announced the day after Kishida stood down—would have done much to change his fate.^[v] The long-running domestic headwinds persist, and economic expectations are meager.

In the coming days, we will learn the runners and riders to succeed him. Hotly tipped names include Digital Transformation Minister Taro Kono, Kishida’s main competition in 2021’s leadership contest and one of Japan’s most popular politicians. He is big on Twitter X and styles himself as a reform-minded maverick, though his policy proposals back then fell short of the tough, structural changes needed to revitalize domestic demand. Former Defense Minister Shigeru Ishiba, who has also run for LDP leader before, is another purported favorite. Cabinet minister Sanae Takaichi, who had strong ties to Abe before his assassination, is rumored to be planning a run.^[vi] And former Environment Minister Shinjiro Koizumi—son of former PM Junichiro Koizumi—is the favorite among those who think a generational shift is in order.

In past leadership contests, the winner was usually the one who either hailed from the biggest faction or had enough support among smaller factions. It was a numbers game, with faction members largely falling in line. But now, factions are gone. Some of the biggest formally disbanded after being implicated in the scandal. Those that remain are just policy groups, similar to the caucuses within the main US political parties. Without those hierarchies whipping party members in line, the contest is probably more open—particularly for Koizumi, who never joined a faction and therefore has less baggage than others.

Regardless, by the end of September, the LDP will have a winner and Japan will have a new PM (given the LDP’s large majority, a confidence vote is a foregone conclusion). However, we doubt the winner will do much legislating, as their main task will be to shore up the LDP’s popularity before 2025’s elections, which are due by October 30 next year. The LDP still leads the competition, but support is down, and if the fragmented opposition comes together it could mount a challenge. This gives a new PM very little incentive to pass major legislation, lest they risk rocking the boat.

So for the time being, we think the leadership change probably extends the status quo, keeping legislative risk low. This could change after 2025’s election, but that is too far out to be a factor for Japanese stocks now, in our view. The time to assess that election and its likely effect on both investors’ expectations and legislative risk will come later next year. For now, Japanese stocks will have what they have had all year: a PM trying to rally public support in the face of scandal and domestic economic headwinds. The face will change, the fundamentals probably won’t.

Therefore, for Japanese stocks, we think it is probably steady as she goes. Yes, Japan tumbled into a bear market as global markets pulled back—but like global markets, it is rebounding. This doesn’t preclude more tremors, but short-term volatility usually fades fast. Looking longer term, Japan is highly correlated with the rest of the world and probably keeps riding global trends. Those trends probably favor its mighty multinationals over firms dependent on domestic demand.