Behind Nikkei's Gains—It's Not Just the Weak Yen
Writer for CNBC.com
Optimism over Prime Minister Shinzo Abe's radical economic policies combined with a rapidly weakening yen pushed Japan's Nikkei 225 past the 12,000 mark for the first time in four-and-a-half years on Thursday. And experts say there is more upside to this rally which is being driven not just by "Abenomics" but improving economic fundamentals as well.
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"We are warning investors not to start getting giddy on the bottom rung of the ladder. The rally has barely started," said Japan strategist at CLSA Nicholas Smith. Tokyo's benchmark index has climbed a whopping 38 percent since November.
"Initially, we are seeing a fantastic firework display, but we will need structural change to keep it going. I'm confident we'll see that. I expect [corporate] profits to rise by 35 percent and it's not unreasonable to see stocks go [up] by the same amount as well," he said.
Investors are hotly anticipating the next Bank of Japan meeting on April 3-4, when new governor Asian Development Bank president Haruhiko Kuroda is expected to start putting Abe's money where his mouth is through aggressive easing measures.
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"Japan has a great deal of upside, I would say up to around 30 percent in the course of this year," said Uwe Parpart of Reorient Financial Markets on CNBC's "Cash Flow" on Thursday.
"Foreign investors have driven the Japanese market since November but the big funds are still underweight Japan. Four trillion yen has been bought in Japanese stocks, there is another 6 trillion yen to go just to get to the levels that foreign investors spent in 2005 and 2006 when they were optimistic on [Prime Minister Junichiro] Koizumi's government," said Parpart.
Jeremy Hall, director of Japan investment at Henderson Global Investors, also drew parallels between today's market in Japan and that of 2003, when the market was on the brink of a 137 percent bull run. The Nikkei surged over a four-year period from below 8,000 in 2003 to over 18,000 by 2007.
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Hall said market fundamentals are more attractive now than they were back then. "You could easily argue that the outlook is now better than at the time of the end of Junichiro Koizumi's administration [2001 to 2006] when the Nikkei was at 16,000. Companies are generally structurally more solid, and valuations are lower now than around that time," said Hall.
According to Hall, investors have an out-of-date perception of Japan's economy and Japan has been structurally stable for some time.
"Japan has been structurally stable for a while now. It did not have a financial crisis post Lehman's Brothers, for example, and now its banks are some of the most stable in the world. However, a number of attempts at cyclical recovery were knocked off course by one-off and external events, such as the tsunami," he said.
The Japanese economy fell back into its fifth recession in 15 years in December but there have been some silver linings since. Last week Japan's retail sales for January beat analyst expectations. Retail sales climbed 2.3 percent month on month, beating economist expectations of a 0.9 percent increase, following a flat reading in December.
(Read More: Japan Consumer Prices Dip for Second Month)
Another encouraging factor is that the general public has prioritized the economy over other political issues, said CLSA's Smith.
"For the first time since 2003, voters are focused on the economy. Until recently welfare was a priority now that has dropped right down. Also the government is completely focused on the economy and will do whatever it takes to revive it. It has a 68 percent super majority so nothing is standing in its way," he said.