Base-case view for Japanese equities: AI inflows return alongside catch-up gains in cyclical value

Overview

This report focuses on Japan's 1Q earnings season and the repricing of the AI theme. The authors argue that the key variable for market direction is the capex plans disclosed by U.S. hyperscalers in their earnings reports. If capex remains strong, global capital may rotate back into AI-related stocks; however, because Japanese AI-related cyclical growth stocks already embed elevated earnings expectations, capital may not concentrate only in the pure AI names that have already risen, but may instead spread to cyclical value stocks that benefit from AI investment while still carrying lower valuations and expectations.

Core views

There are three core views. First, the base case is not a binary choice between “AI or value,” but rather the coexistence of “AI inflows returning” and “catch-up gains in lagging cyclical value.” Second, earnings for AI-related cyclical growth stocks have not deteriorated, but the earnings hurdle implied in their share prices has risen materially; if earnings are merely decent on the surface and fail to exceed lofty market expectations, the stocks may come under pressure. Third, cyclical value stocks with earnings growth, high market beta, low P/B, and insufficient prior upside may enjoy a double boost from both earnings upgrades and valuation re-rating as the benefits of AI investment spread.

Analysis framework

The report combines scenario analysis, factor observation, and stock screening: it first sets out three market paths under different AI capex and earnings outcomes, then examines the TOPIX 500 momentum factor, earnings revision indices for AI-related industries, credit spreads, and theme performance, and finally screens TOPIX constituents for cyclical growth and cyclical value stocks based on FY26 EPS growth, market beta, P/B, and three-month momentum.

Methodology notes

• scenario_analysisThree-scenario market path

  AI capex and earnings expectation scenarios

  The report presents three scenarios: strong capex drives a return to AI and is accompanied by catch-up gains in cyclical value; AI companies' earnings materially exceed high expectations and capital becomes concentrated again in AI cyclical growth; or AI companies fail to clear the high earnings hurdle while geopolitical and supply-chain risks rise, triggering lower risk appetite and de-positioning in high-beta AI stocks.

• factor_analysisMomentum and valuation factor observation

  TOPIX 500 momentum, P/B, and beta

  The report focuses on the potential recovery of the momentum factor after a roughly 20% pullback from its late-June high, and uses P/B and three-month momentum to distinguish high-expectation cyclical growth from lagging cyclical value.

• stock_screeningCyclical growth and cyclical value screening

  FY26 EPS growth, market beta, P/B, and three-month momentum

  Within the TOPIX universe and excluding banks, the report first selects stocks in the top 50% for FY26 EPS growth and top 30% for market beta, then uses P/B as the primary classification metric and three-month momentum as a supplementary filter to identify high-expectation cyclical growth and cyclical value with catch-up potential.

• macro_policyInstitutionalized fiscal expansion framework

  Japan fiscal expansion, yen weakness, and bank stocks

  The report argues that the 2026 Basic Policy shows fiscal expansion is becoming embedded in the policy framework, and concerns about weaker fiscal discipline and constraints on BOJ rate hikes may be expressed through yen weakness and falling bond prices, making bank stocks beneficiaries of higher rates and a hedge against AI pullbacks.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Japanese AI-related cyclical growth stocks

  Directly driven by U.S. hyperscaler capex and the AI investment cycle

  Strengths

  If major U.S. cloud providers confirm strong capex, momentum and earnings revision factors may recover quickly, and some cyclical growth stocks with strong upward revisions could outperform.

  Weaknesses

  Valuations and earnings expectations are already high, so earnings need to materially exceed market expectations to continue supporting share prices.

  Comparison

  Versus cyclical value stocks, upside sensitivity is more direct but the expectation hurdle is higher, and the earnings risk-reward has worsened.

  Risks

  Earnings falling short of high expectations, geopolitical risks, supply-chain concerns, widening credit spreads, and de-positioning in high-beta names.

• Japanese cyclical value stocks

  May benefit as the gains from AI capex spread from pure AI names to upstream and adjacent industry chains

  Strengths

  Valuation discounts have widened and market expectations are lower; if earnings beat expectations, these stocks may benefit from both earnings upgrades and valuation re-rating.

  Weaknesses

  If AI stocks rebound strongly and capital rotates out of defensive or value trades, short-term fund flows may reverse.

  Comparison

  Relative to cyclical growth stocks, the earnings growth outlook is similar but the implied earnings hurdle is lower, while catch-up upside depends more on evidence of spillover.

  Risks

  Macro uncertainty, weaker-than-expected demand recovery, limited spillover from AI investment, and earnings failing to confirm operational improvement.

• Japanese bank stocks

  Benefit from yen weakness, higher-rate expectations, and yield moves driven by fiscal concerns

  Strengths

  They are both beneficiaries of higher rates and, in the short term, hedge assets against volatility in AI-related stocks.

  Weaknesses

  If the government constrains BOJ rate hikes or expectations for higher rates fade, the core catalyst may weaken.

  Comparison

  Relative to AI-chain stocks, bank stocks are more exposed to macro rates and FX rather than being direct beneficiaries of AI capex.

  Risks

  A BOJ policy path below expectations, unfavorable yield-curve changes, and credit risk or lower market risk appetite.

• Cybersecurity, network infrastructure, and AI implementation support

  Driven by a growing base of AI model users and rising demand for data protection and model governance

  Strengths

  Open models such as Kimi K3 may accelerate the spread of AI applications, increasing demand for the infrastructure and services needed to use AI safely.

  Weaknesses

  These themes have previously lagged due to AI disruption concerns, and the pace of earnings realization still needs to be verified.

  Comparison

  Relative to frontier model companies, these areas are more geared toward application-layer and security/compliance benefits, and may share in broader growth in AI usage.

  Risks

  Slower-than-expected AI adoption, insufficient enterprise security budgets, intensifying competition, and a thematic rebound lacking earnings support.

Key data

• Report date2026-07-24The top of the page shows July 24, 2026.
• U.S. hyperscaler 2027 capex forecast约US$1.2 trillionMorgan Stanley forecasts this at about 30% above the market consensus of US$0.9 trillion.
• U.S. hyperscaler 2028 capex forecast约US$1.4 trillionMorgan Stanley forecasts this at about 40% above the market consensus of US$1.0 trillion.
• Recent momentum factor pullback约20%The report says the TOPIX 500 momentum factor fell about 20% from its recent high at the end of June as of last week.
• Yaskawa Electric caseDown 14.3% the day after earnings, with the decline widening to 26.6% after five trading daysThe report uses its adjusted beta of about 1.59 to illustrate the amplified downside risk for high-expectation, high-beta cyclical growth stocks when earnings disappoint.
• Future financing cost structure of data centersServers, chips, compute, and energy infrastructure account for about 60% of total costThe U.S. credit strategy team expects the financing focus to shift from data center shell construction to chips, compute, and energy infrastructure.
• Public and private investment roadmapCumulative total of more than ￥370 trillion by FY2040This investment roadmap is mentioned in the section related to Japan's Basic Policy.
• Assumption for potential additional fiscal spendingAbout ￥10 trillion per yearThe report believes the policy estimates imply about ￥10 trillion in additional annual spending.

Impact & implications

The portfolio implication is that Japanese market allocation should not be simply split into AI growth on one end and non-AI value on the other. If U.S. hyperscalers continue to validate strong capex, AI-related stocks may still recover momentum; however, the better risk-reward may come from cyclical value stocks that benefit from AI investment spillovers, trade on lower valuations, and face lower earnings hurdles. At the same time, against a backdrop of fiscal expansion and yen weakness, bank stocks can serve as beneficiaries of higher rates and as a hedge against volatility in AI-related stocks; after AI model competition broadens, cybersecurity, network infrastructure, and AI implementation support may emerge as beneficiaries at the application layer.

Risks

• U.S. hyperscaler earnings fail to confirm strong capex plans, reigniting concerns over the AI investment cycle.
• Japanese AI-related companies fail to clear the significantly raised earnings expectation hurdle.
• Geopolitical risks such as in the Middle East, supply-chain concerns, or widening credit spreads trigger lower risk appetite.
• High-beta AI-related stocks undergo de-positioning, accelerating the momentum reversal.
• If AI stocks rebound strongly, defensive capital that recently flowed into bank stocks, domestic demand stocks, or some value stocks may reverse.
• Japan's fiscal expansion assumptions, BOJ policy direction, or yen trajectory diverge from the report's view.
• Application-layer beneficiary themes such as cybersecurity may remain only at the valuation-repair stage without near-term earnings validation.

What to watch

• Capex plans and 2027-2028 guidance from U.S. hyperscalers in 1Q earnings reports.
• Credit spread changes in the U.S. credit market for financing by large technology companies and hyperscalers.
• Whether Japanese AI-related companies can beat already-elevated market expectations in 1Q earnings.
• Whether the TOPIX 500 momentum factor recovers from its recent roughly 20% pullback.
• Whether cyclical value stock earnings show upside surprises, guidance upgrades, or valuation re-rating signals.
• Whether the KOA case shows AI capex gains spreading into adjacent fields such as electronic components and industrial equipment.
• Market reactions after Japan's Basic Policy in fiscal expansion, the yen, bond prices, and BOJ rate-hike expectations.
• Order flow or earnings evidence for cybersecurity, network infrastructure, and AI implementation support after the spread of open AI models such as Kimi K3.