Japanese equities have been soaring to unprecedented levels, buoyed by increased confidence in the nation’s political scene and the economic strategies of the current government. However, analysts caution that this market exuberance might not align with the underlying economic realities.

The Nikkei 225 has recently achieved significant milestones, surpassing 56,000 and 57,000, and edging closer to 58,000. This surge is attributed to the so-called “Takaichi trade,” following Prime Minister Sanae Takaichi’s decisive victory in the Lower House elections.

On Tuesday, the stock market, which was closed for a holiday on Wednesday, saw the Nikkei peak at 57,960. The index has risen by approximately 15% this year.

Market observers note that the rally has been significantly driven by political optimism, stemming from Takaichi’s robust electoral success. Investors are enthusiastic about potential increases in government spending, tax cuts, and a more proactive economic policy. 

However, analysts caution that enthusiasm may be running ahead of clarity on how those policies will be funded, and that Japan’s current equity market foundations look increasingly fragile: vulnerable to currency moves, global shocks and a growing gap between prices and fundamentals.

Richard Harris, chief executive officer at investment management firm Port Shelter, said the market’s current gains are difficult to justify purely on economic strength: “It’s not really driven by fundamentals. If you’re looking at how the currency is moving, how the economy is doing … there’s nothing really particularly strong on it to justify the move in the market.”

On a quarter-on-quarter basis, Japan’s economy shrank 0.4% in the three months to September, contracting for the first time in six quarters, government data released in November showed. It contracted 1.8% on an annualized basis.

The country is the most indebted nation in the world, with a debt-to-GDP ratio of almost 230% in 2025, data from the International Monetary Fund showed, and increased fiscal spending risks piling more debt.

The government in November approved a fiscal stimulus package of over $135 billion, warranting increased borrowing.

Harris said sentiment, liquidity and narrative were the dominant forces steering the market. “We’ve seen that in other markets too,” he said, adding that Japan was not unique in breaking records amid global enthusiasm for equities and AI-related investment.

Moody’s senior economist Stefan Angrick echoed that the AI boom had lifted stocks globally, and that was visible in Japanese equities as well.

“The current situation probably looks a little bit fragile in the sense that valuations are driven by the global equities boom,” Angrick told CNBC.

Japan’s heavy exposure to global manufacturing and capital goods has made it a prime beneficiary of the AI build-out. But that linkage also leaves the market sensitive to any cooling in global tech enthusiasm, or to shifts in its currency that has quietly done much of the heavy lifting, he said.

That sensitivity has become more apparent in recent months, worries over an AI bubble have led to market volatility, including in Japanese stocks. Last week, the software sector saw a sell-off after artificial intelligence company Anthropic released new AI tools designed to handle complex professional workflows that many software firms offer as core services.

What also makes the current level of valuation a bit fragile is the yen, Angrick added. The yen has weakened quite a bit in the past year, which tends to be positive for equities in Japan given how a sizable proportion of the market comprises exports-reliant manufacturers.

A weaker yen boosts earnings and inflates equity valuations, but that could fade over time. “The yen is trading very far from fundamentals. Basically, it’s too weak. It’s unreasonably weak,” he said.

The Japanese yen has weakened about 3.67% against the dollar in the last six months, data from LSEG showed.

Japan has signaled that it could intervene if the yen slide continues, with Japan’s Finance Minister Satsuki Katayama even conveying concerns to U.S. Treasury Secretary Scott Bessent over the yen’s “one-sided depreciation.”

Aberdeen Investments expects the yen to appreciate from a gradual increase in real rates as inflation is set to slow more than is currently appreciated.

Angrick also anticipates the currency to strengthen. “The expectation is that over the medium term,  the yen should appreciate, and that we’ll see equity valuations come down a little bit,” adding currency normalization could “take quite a big chunk out of where equities are right now.”

However, that is not to say that Japan’s stock market boom has no legs. 

Structural reforms in recent years, particularly around corporate governance, capital efficiency and shareholder returns, have provided durable growth, experts said. Companies have stepped up share buybacks, unwound cross-shareholdings and focused more aggressively on return on equity, a shift encouraged by the Tokyo Stock Exchange.

Some asset managers argue that Japan’s corporate fundamentals remain broadly supportive, but only if expectations are met.

Zuhair Khan, portfolio manager at Union Bancaire Privée, said the rally is “genuine” to the extent that a strong, stable government gives the market confidence, but warned that prices already assume progress that has yet to materialize. 

“The market is already pricing in some improvements that have not yet happened,” he said, citing expectations for asset sales, buybacks and margin improvement. That leaves little room for disappointment.

“If the pace of improvement slows down, then there is downside risk,” Khan said.