The Valuation Gap Is Difficult to Ignore

Investors do not buy equities for certainty. They accept unstable prices, uncertain profits and the possibility that even a good company can become a poor investment when too much optimism is already reflected in its share price. The relevant question is whether they are being paid enough to take those risks instead of owning government bonds

One useful, though simplified, measure is the forward earnings yield minus the domestic ten-year government-bond yield. Nikkei's official data show that JPN225 has a current market-cap-basis P/E of 17.82. Nikkei calculates this measure using the combined market capitalisation and estimated earnings of the index constituents. Because SPX500 is itself market-cap weighted, this is the more comparable Nikkei measure for the purpose of this exercise.

A P/E of 17.82 translates into an earnings yield of 5.61%. Japan's ten-year government-bond yield is around 2.78%, leaving a simplified equity risk premium of approximately 2.83%.

The equivalent cushion for SPX500 is much thinner. FactSet reports a current forward 12-month P/E of 20.1. That produces an earnings yield of 4.98%. The current US ten-year Treasury yield is arounds 4.64%, leaving a equity risk premium of only 0.34%.

On this basis, JPN225 offers investors roughly 2.4 percentage points more earnings yield over its domestic ten-year bond than SPX500 does.

What Investors Are Actually Being Paid For

That gap does not guarantee that Japanese equities will outperform. Nor does it prove that Japan is the safer market. It means something more modest, but still important, that investors are paying less for Japan's estimated corporate earnings relative to the return available from Japanese government bonds.

SPX500 may still deliver superior returns if US earnings continue to grow strongly enough to justify its valuation. The difficulty is that a premium of barely 0.3 percentage points leaves little room for error. A rise in Treasury yields, a reduction in earnings forecasts or a loss of confidence in current growth assumptions could quickly erase the remaining cushion.

JPN225 provides more breathing room. Its wider premium offers greater protection against moderate earnings disappointment or higher bond yields, although it certainly cannot protect investors against a severe downturn.

Japan also has a potential structural catalyst. The Tokyo Stock Exchange continues to press listed companies to manage with greater awareness of their cost of capital, profitability and market valuation. Its April 2026 update placed particular emphasis on how companies allocate management resources in pursuit of sustainable growth and stronger medium- to long-term corporate value. In July, TSE published a revised Corporate Governance Code, with related listing-rule changes taking effect on 21 July. The reforms encourage boards to set clearer growth strategies, explain their capital-allocation decisions and review whether corporate resources are being used effectively.

The Wider Premium Comes with Real Risks

There is a temptation to stop at the valuation gap and declare Japan the obvious bargain. That would be a mistake. JPN225 is a price-weighted and highly concentrated index. Technology represented 55.6% of the index at the end of June, while Advantest and Tokyo Electron alone accounted for 20.28%. SoftBank Group and Kioxia added further exposure to the global technology and artificial-intelligence investment cycle.

That concentration helps explain why JPN225 frequently takes its lead from US semiconductor sentiment and why its relationship with iShares Semiconductor ETF can become exceptionally strong. On 24 July, for example, Japanese chip-related shares fell sharply as concerns about the scale and eventual returns from AI spending spread from the US market into Japan.

Japanese investors are therefore being compensated for genuine risks, including cyclical semiconductor earnings, shifting AI expectations, rising domestic bond yields and currency volatility.

Whilst calculation methodologies are not exact, the conclusion remains persuasive. SPX500 asks investors to pay a higher price and place considerable faith in future earnings. JPN225 asks them to accept a different and increasingly technology-heavy collection of risks, but, for now, it appears to be paying them considerably more for doing so.

References

• https://www.jpx.co.jp/
• https://www.jpx.co.jp/
• https://indexes.nikkei.co.jp/
• https://insight.factset.com/
• https://indexes.nikkei.co.jp/