Japan's Stabilizing Corporate Sentiment: Implications for Equity Markets

Japan's corporate sector is navigating a delicate balancing act in Q3 2025, with stabilizing-but not robust-sentiment metrics signaling cautious optimism. The Bank of Japan's Tankan survey, a barometer of business confidence, reveals a mixed picture: while large manufacturers show resilience, smaller enterprises and non-trade sectors face headwinds. For investors, this nuanced landscape offers both caution and opportunity, particularly as equity markets react to structural reforms, reflationary trends, and evolving monetary policy.

Tankan Insights: Stability Amid Sectoral Divergence

The Q3 2025 Tankan survey underscores a stabilization in corporate sentiment, with the manufacturing index at 14.0-slightly below expectations but unchanged from the prior quarter-and the non-manufacturing index holding steady at 34.0, according to the BOJ Tankan outline BOJ Tankan outline. Large manufacturers, however, outperformed smaller counterparts, with their index rising to 14.0 from 13.0 in Q2 2025, as reported in the InvestingLive report InvestingLive report. This divergence reflects the uneven impact of global trade dynamics and domestic reforms. For instance, the U.S. tariff agreement, which reduced auto import tariffs from 25% to 15%, provided a temporary boost to manufacturer confidence, as noted in a MarketBeat article MarketBeat article.

Conversely, medium and small enterprises faced sharper declines. Medium-sized manufacturers dropped from 11 to 10, while small manufacturers fell from 2 to 1, according to the BOJ Tankan outline. Non-manufacturing sectors, though stable at 34.0, saw a -7-point forecast decline in September 2025, signaling lingering uncertainties, as the InvestingLive report also observed. These trends highlight the fragility of Japan's recovery, particularly for firms reliant on domestic demand or vulnerable to global supply chain disruptions.

Equity Market Implications: Sectors in Focus

The Tankan's mixed signals align with divergent equity sector performances. Domestically oriented sectors-such as healthcare, consumer durables, and financials-are gaining traction as private consumption and wage growth drive demand, according to an Investing.com outlook Investing.com outlook. For example, the Nikkei 225 surged 11% since July 2025, fueled by corporate reforms, including share buybacks and capital reallocation, and a return of foreign investors, a Lombard Odier note said Lombard Odier note. Technology stocks like SoftBank Group and Advantest have been key contributors, with SoftBank surging over 10% on a major cloud-computing deal in a CNBC report CNBC report.

Conversely, sectors with high international exposure-such as food and utilities-remain vulnerable to trade tensions and currency volatility. The yen's sensitivity to U.S. monetary policy and Japan's rate differential with the Federal Reserve continues to weigh on export-dependent firms, according to NAI500 analysis NAI500 analysis. However, the BoJ's normalization of interest rates, including its exit from negative rates in 2024, has supported earnings upgrades and a favorable 2026 outlook, as noted by Lombard Odier.

Valuation Trends and Investment Flows

Japanese equities are increasingly attractive as valuations normalize. The Nikkei 225's 23.13% annual gain reflects a shift in household savings from cash to risk assets, accelerated by the Nippon Individual Savings Account (NISA) tax-exempt system, according to a Morgan Stanley outlook Morgan Stanley outlook. This retail-driven inflow, combined with returning foreign capital, has bolstered market resilience. Institutional investors, including domestic pension funds, are also reallocating to equities as a hedge against inflation, as highlighted in an RBC BlueBay report RBC BlueBay report.

Notably, Japan's underrepresentation in global portfolios presents a compelling entry point. Analysts at RBC BlueBay and Bernstein highlight that domestically focused sectors are well-positioned to benefit from rising consumption and wage growth, while the BoJ's expanded Tankan wage tracking will provide clearer inflation signals, according to Trading Economics data Trading Economics data.

Risks and Strategic Considerations

Political instability, including Prime Minister Ishiba's resignation and leadership contests, introduces short-term volatility. However, reform-focused policies are expected to persist, supported by Japan's strong net savings and current account surplus, as Lombard Odier has observed. Additionally, fiscal stimulus risks could influence bond yields, though these are seen as manageable in the context of broader reflation.

For strategic entry, investors should prioritize sectors with strong domestic demand and robust capital allocation practices. Defensive plays in healthcare and utilities may offer stability, while growth opportunities in technology and consumer durables align with long-term structural trends.

Conclusion

Japan's corporate sentiment, while stabilizing, remains a mosaic of resilience and vulnerability. The Tankan's sectoral divergence underscores the importance of a nuanced investment approach, balancing exposure to reform-driven growth with caution against external risks. As the BoJ navigates normalization and households shift toward risk assets, Japanese equities present a compelling case for strategic entry-particularly for those aligned with domestic demand and structural reforms.