This Asian Nation's Stocks Are Beating America and the World. Should You Invest $1,000?

During the past year, Japan's stock market has outperformed the S&P 500 index and the rest of the world. That's right: Japan's Nikkei 225 index is up 38.6% since January 2025. During that timeframe, the S&P 500 index has gained 15.7% and the Vanguard Total World Stock Market Index ETF, an index of 9,950 international stocks, has gained 21.3%.

Japan is famous for its "lost decades" of stock market decline and stagnant growth. In 1989, Japan's stock market crashed, leading to many years of drawdowns. But in the past few years, the Land of the Rising Sun's stock market has risen again.

An easy way for American investors to "buy Japan" is to invest in the iShares MSCI Japan ETF (NYSEMKT: EWJ). This index ETF of large and mid-sized Japanese companies has gained 29.2% in the past year. Here's a closer look at what's driving the rise of Japanese stocks.

Reasons for optimism about Japan's economy

A few recent developments in Japan's politics and economy are making investors feel bullish about Japanese stocks. These include:

• More government spending: Japan recently elected a new prime minister, Sanae Takaichi, who has pledged to stimulate the economy with more government spending.
• Political capital: Takaichi has a strong approval rating (64% as of December 2025). Her popularity could give her the political leeway to move decisively and enact powerful reforms.
• Better corporate governance: In the past few years, Japan's regulatory authorities and the Tokyo Stock Exchange have made changes in corporate governance to make Japanese companies more investor friendly.
• Continued economic growth in the U.S.: America is one of Japan's largest trading partners, purchasing 21% of Japan's exports as of 2024. With economists expecting the U.S. to have 2.1% GDP growth in 2026, that's good news for stocks of Japanese companies that sell to the U.S. market.

If you believe in the future growth prospects of leading Japanese companies, you might want to invest in the iShares MSCI Japan ETF. This ETF holds 181 stocks. Its top five holdings are:

• Toyota Motor, a major auto manufacturer (4.59% of the ETF)
• Mitsubishi UFJ Financial Group, a financial services firm (4.43%)
• Hitachi, a large industrial company (3.20%)
• Sony Group, a consumer electronics company (3.13%)
• Sumitomo Mitsui Financial Group, a financial services company (2.71%)

This fund is highly diversified, with no company making up more than 5% of the holdings. The ETF expense ratio, which includes a management fee, is 0.49%. This fund is a relatively low-cost way to make a targeted investment focused on the Japanese market.

Japan's economy faces a few risks. If Prime Minister Takaichi sees her popularity decline, the government might get gridlocked and fail to pass a substantial reform agenda. Japanese inflation is another concern; higher government borrowing could drive higher interest rates and a weaker yen.

American tariffs could be another risk to Japan. The U.S. currently collects a 15% tariff on nearly all Japanese imports, based on an agreement signed in July 2025. But if America decides to change its trade policy in a way that's unfavorable to Japanese companies, investors could take a hit.

Image source: Getty Images.

Japanese stocks are cheaper than American stocks

Even though Japanese stocks have outperformed America and the world in the past year, they still might be undervalued. The trailing 12-month price-to-earnings ratio for the iShares MSCI Japan ETF is 19.9. That compares favorably to a P/E ratio of 31.3 for the S&P 500.

If Prime Minister Takaichi and her government can unleash economic stimulus, drive corporate governance reforms, and avoid excessive inflation, Japan's stock market could keep its momentum going in 2026. The iShares MSCI Japan ETF gives investors an easy way to get exposure to this future growth opportunity.

Ben Gran has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.