Navigating Tariff Turbulence: Undervalued Gems in Japan's Equity Market

The U.S.-Japan trade dispute, marked by escalating tariffs on autos and steel, has cast a shadow over Japan's export-reliant economy. Yet beneath the headline risks, sectors like consumer cyclicals, healthcare, and industrials are proving resilient—bolstered by domestic demand, global diversification, and structural growth drivers. For investors willing to sift through near-term volatility, Japan's equity market offers compelling opportunities. This analysis highlights undervalued companies positioned to thrive despite trade uncertainties, while advising caution in tariff-hit sectors like autos and steel.

Consumer Cyclicals: Domestic Demand as a Shield

Japan's consumer cyclicals sector, insulated by strong domestic consumption, presents a haven from U.S. tariff pressures. LY Corporation (ticker: 2121.T), a media and tech conglomerate, exemplifies this resilience. Its core assets—Line, Japan's dominant messaging app, and PayPay, the leading QR payment platform—serve as essential social infrastructure. With minimal U.S. exposure, LY Corp benefits from rising digital adoption and cross-selling opportunities.

Morningstar's undervaluation score of 4.5/5 reflects LY Corp's robust free cash flow and low debt. Meanwhile, Oriental Land (4661.T), operator of Tokyo Disney Resort, derives over 75% of revenue from domestic visitors. As Japan's wage growth and tourism rebound post-pandemic, its moat remains intact.

Healthcare: Innovation and Defensiveness

Japan's healthcare sector, driven by an aging population and R&D breakthroughs, offers steady growth insulated from trade disputes. Daiichi Sankyo (4568.T), a global leader in antibody-drug conjugates (ADCs), is a prime example. Its lead asset, Enhertu (trastuzumab deruxtecan), is transforming treatment for HER2-positive cancers, with a pipeline extending to lung and breast cancers.

Despite a temporary setback in 2024 over Dato-DXd trial data, Morningstar assigns a 4.0/5 undervaluation rating, citing Enhertu's $1.5 billion peak sales potential. Olympus (7733.T), meanwhile, leverages its dominance in endoscopes—a critical tool for early cancer detection—to grow globally. Its CEO-led turnaround and minimal U.S. tariff exposure (only 10% of revenue from China) further solidify its case.

Industrials: Global Reach and Energy Efficiency

In industrials, Daikin Industries (6471.T), a global HVAC leader, thrives on structural trends like decarbonization and urbanization. Its high-efficiency air conditioners and refrigeration systems cater to demand in Asia, Europe, and the U.S., where energy efficiency mandates are tightening.

Morningstar's 4.3/5 undervaluation score underscores its 15% annual earnings growth potential through 2027. Asahi Group Holdings (2518.T), though technically a consumer staples firm, benefits from its industrial beverages business in Australia and Eastern Europe. A recent government pause on beer tax hikes in Australia adds near-term upside.

Caution: Autos and Steel—Tariff Hotspots

While sectors like healthcare and consumer cyclicals are insulated, autos and steel remain vulnerable. U.S. tariffs on Japanese autos could rise to 30-35% post-July 2025 if negotiations stall. Automakers like Toyota (7203.T) and Honda (7267.T) face margin pressure unless they shift production to USMCA-compliant regions. Similarly, Nippon Steel (5401.T) grapples with 50% U.S. tariffs on steel exports, squeezing margins as costs for machinery manufacturers spike.

Investment Strategy: Selectivity is Key

The path forward demands a sector-agnostic, valuation-driven approach:
1. Buy the undervalued innovators: Daiichi Sankyo (Enhertu's growth) and LY Corporation (digital dominance) offer high upside relative to risks.
2. Prioritize domestic champions: Oriental Land and Asahi Group benefit from Japan's economic reopening and stable consumer spending.
3. Avoid tariff-exposed names: Autos and steel companies warrant caution until trade terms crystallize.

Morningstar's metrics and scenario analysis confirm that Japan's equity market is not a monolith—selective buying in resilient sectors can yield returns even amid geopolitical noise.

Conclusion

Japan's equity market is a mosaic of contrasts: vulnerability in export-heavy sectors versus strength in domestically driven or globally diversified firms. By focusing on companies like LY Corporation, Daikin, and Daiichi Sankyo—those insulated by demand or innovation—investors can navigate tariff turbulence. The key lies in ignoring the headlines and anchoring decisions to fundamentals. As Morningstar's data underscores, patience and selectivity will be richly rewarded.

Investment advice: Consider a diversified portfolio tilted toward consumer cyclicals, healthcare, and industrials, with strict avoidance of auto/steel stocks until trade risks abate.