Bernstein: After software stocks outperform, Japanese AI hardware valuations pull back, and a window for positioning is opening

Bernstein gives a positive assessment of Japan's IT hardware and electronics sector: it notes that fundamentals remain strong and that market sentiment toward AI is overly pessimistic. Over the past quarter, software and IT services stocks rose about 30%, while AI-related stocks came under valuation pressure due to overly high expectations; yet FY26 earnings expectations were revised up by 2% to 11% overall during the same period, making the valuation pullback an entry window instead. Bernstein said Hitachi and Mitsubishi Heavy Industries are its long-term top picks, and Murata is currently the best entry point. Murata, Hitachi, NEC, Mitsubishi Electric and Mitsubishi Heavy Industries all carry the firm's "Outperform" rating. The firm is bullish on three main themes: software and cybersecurity, AI components, and energy and defense, with different emphasis for long-term allocation versus the current entry timing. Three main themes Theme one: software and cybersecurity. Japan's domestic software investment growth is expected to rise from +7.5% in 2025 to +10.3% in 2026; investor days at Fujitsu and Nomura Research Institute confirmed strong demand for IT modernization, data and AI; Japanese companies are frequently hit by cyberattacks, raising the urgency of cybersecurity orders, and the sector as a whole benefits from accelerating domestic demand. Theme two: AI components (MLCC). MLCC (multilayer ceramic capacitor) supply and demand are somewhat tight, with the book-to-bill ratio holding at 1.5; Japan's MLCC exports rose 30% year on year in July-August, pointing to high revenue growth this quarter. Yageo, Samsung Electro-Mechanics and Taiyo Yuden have already led with price increases of 10% to 20%, and the implementation of price hikes is the key catalyst for this sector; BBU (battery backup unit) and CBU (capacitor backup unit) bring structural incremental demand, but an influx of new players is intensifying competition. Theme three: energy, defense and the yen. Consensus expectations for grid business are for year-on-year growth of 25% to 30%; global gas turbine demand is expected to rise from 91 GW in 2025 to 100-120 GW, gas turbine orders are likely to beat expectations, and defense sector revenue is expected to keep growing about 20%. This quarter, the US dollar depreciated against the yen from 145 to 159, benefiting export-oriented sectors overall.