Min Zeng

Japanese equities have performed strongly this year, supported in part by enthusiasm around AI-related opportunities. As markets entered the third quarter, however, they began to digest the narrow rally that drove Q2 performance. Semiconductor and AI-related stocks have pulled back notably, but Min Zeng, portfolio manager, Fidelity International, views this primarily as a reassessment of valuations and earnings expectations rather than a meaningful deterioration in corporate fundamentals.

Min Zeng comments: “The key point is that the market appears to be shifting from a theme-led phase to one more focused on earnings delivery. Demand for AI infrastructure, data centres, memory, advanced components and related supply-chain investment remains intact, but investors now require clearer evidence of order growth, pricing power, margin resilience and guidance support. In this environment, companies that can convert strong demand into sustainable earnings and returns on capital should be better placed than those relying mainly on thematic momentum.

“Japanese companies continue to occupy important positions across the AI value chain, including memory and storage, advanced substrates, passive components, power semiconductors, optical components, industrial automation and precision manufacturing. While some of these areas have faced near-term valuation pressure, the pullback appears to reflect a rebalancing of crowded positions after strong prior gains, rather than a reversal in underlying demand trends.

“Beyond the semiconductor supply chain, we remain constructive on selected areas linked to electrical equipment, industrial automation and power infrastructure. As AI adoption expands, investor attention is broadening from computing capacity to the infrastructure needed to support AI deployment, including transmission and distribution networks, cooling technologies and data-centre-related equipment. While Japanese companies possess strong technological advantages across these sectors, selective positioning and a disciplined focus on valuations remain essential.

“Financials are also an important area of opportunity. The Bank of Japan’s gradual policy normalisation should support a more favourable earnings environment for banks through improving net interest margins and reinvestment income. At the same time, corporate governance reform is encouraging better capital allocation, higher dividends and share buybacks. As market leadership broadens beyond AI-related names, selected financial companies with resilient earnings profiles and attractive valuations have shown relative strength.

“We continue to see opportunities in companies linked to infrastructure investment, defence spending and corporate capital expenditure. Supply-chain reconfiguration, energy transition, infrastructure modernisation and national-security investment are creating demand for industrial equipment, engineering and advanced manufacturing technologies. In parallel, labour shortages and the need to improve productivity should support investment in automation, machinery and related infrastructure.

“Looking ahead, Japanese equities are likely to experience further volatility as investors assess earnings results and reset expectations after a strong rally. Nevertheless, the broader investment case remains intact. Current market dynamics suggest rotation rather than a broad withdrawal from risk assets. As Japan moves from an AI-driven market to a more earnings-driven market, active stock selection should become increasingly important.”

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This resignation continues Japan’s cycle of short-lived leadership since Shinzo Abe.

Prime Minister Shigeru Ishiba announced his resignation after just eleven months in office, taking responsibility for the ruling coalition’s defeats in both the lower and upper house elections. His position had been further undermined by persistent inflation, and the imposition of reciprocal U.S. tariffs under President Trump. Although Ishiba initially argued for stability in navigating the trade deal, internal pressure within the Liberal Democratic Party (LDP) became decisive, with senior figures pushing for an early leadership contest.

This resignation continues Japan’s cycle of short-lived leadership since Shinzo Abe. The LDP will now hold a leadership election, with candidates such as Sanae Takaichi (Minister of State for Economic Security), Shinjiro Koizumi (Minister of Agriculture, Forestry, and Fisheries), and Yoshimasa Hayashi (Chief Cabinet Secretary) in contention. The eventual outcome will determine whether policy moves in a more hawkish, expansionary direction or remains closer to Ishiba’s cautious style.

Ishiba’s departure raises expectations of more expansionary fiscal and monetary policies, which is already weighing on Japanese government bonds and the yen. Further fiscal stimulus, aimed at restoring confidence in the domestic economy, is anticipated. While this environment may benefit equity markets, particularly domestically focused sectors such as infrastructure, construction, and consumer cyclicals, exporters remain vulnerable to U.S. tariffs and exchange rate volatility.

The agreement with Washington reduces immediate trade uncertainty but does not eliminate longer-term risks. A hawkish successor could align Japan more firmly with U.S. security and foreign policy priorities, creating new complexities in regional relations.

Against this backdrop, businesses whose earnings are relatively insulated from global macro swings and which benefit from domestic reform tailwinds could benefit. Sectors like construction, financials, industrials and utilities have relatively limited sensitivity to US tariff outcomes and enjoy steady pricing power as labour shortages, digitalisation and infrastructure demand drive order books. As we head towards the FY25 interim results season, it is important to remain focused on company fundamentals.

By Min Zeng, Portfolio Manager

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