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Goldman Upgrades Japan Stocks, Sees Further 20% Upside

In further evidence of growing exuberance over prospects for Japanese stocks, U.S. investment bank Goldman Sachs late Thursday upgraded its 12-month target for both Japanese benchmarks - the Nikkei and Topix - on expectations of bumper earnings growth.

It increased its target for Nikkei to 16,000 from 15,000 and for the Topix to 1,350 from 1,250 earlier, which marks a near 20 percent upside from current levels.

"Last week's announcement by [Bank of Japan] Governor Haruhiko Kuroda was the most credible attack on deflation that Japan has seen in a very long time, there's prospect for Japan to exit this liquidity trap and get its domestic economy back on its feet," Kathy Mitsui, chief Japan strategist at Goldman Sachs told CNBC on Friday.

(Read More: BOJ Throws In Kitchen Sink in War With Deflation)

For the Topix, Mitsui forecasts earnings per share growth of 54 percent in the fiscal year ending March 31, 2014 and 23 percent in following year, driven by expectations of stronger gross domestic product (GDP) growth in the world's third largest economy and continued weakness in the yen. The bank expects the yen to weaken to 105 against the U.S. dollar by the end of the year, and to 110 in 2014.

Gains in the Topix - which has risen almost 60 percent since mid-November when Prime Minister Shinzo Abe unveiled in his bold election campaign to boost the economy with expansionary fiscal and monetary policies - have largely be driven by foreign investor inflows. Japan's equity markets have seen $60 billion in foreign inflows over this period, which has also pushed the Nikkei up over 55 percent.

And, while this will continue to be a major force for the country's stocks, Mitsui said, there is also potential for domestic retail investors to increase their participation in the market.

(Read More: Uniqlo Shrugs Off Row, Picks China for Biggest Store)

"Retail investors are gradually beginning to sniff around looking at higher yielding names. There is going to be a time when some domestic money, particularly retail and mutual fund money begins to trickle in again," she said.

Betting on Consumption

As Japanese corporates experience an upswing in profits, Mitsui expects companies will begin to share the fruits of their recovery with workers, providing a boost to consumption.

There has been anecdotal evidence of some corporates in the auto and retail space beginning to offer bonuses, she said, adding that this trend will likely become more widespread by next year.

Based on expectations of increased spending, Goldman recommends investing in department stores, luxury property developers, high-end housing equipment companies, and travel and leisure firms.

(Read More: Demand Up 50% on 'Abenomics,' Says Property Head)

"Those areas are going to see the light of day finally as the economy emerges from an environment of falling to rising prices," she said.

Key Risk to Forecast

Mitsui, however, cautioned that the bank's forecast isn't without risks, identifying policy implementation as a possible hurdle for the market.

"The investor base has raised their expectations for 'Abenomics.' He started with the first two prongs of his growth strategy - the fiscal stimulus and now the monetary stimulus is coming through - but the third leg of that still remains structural reforms," she said.

(Read More: 'Abenomics' Gamble: How to Tell If It's Paying Off)

"But there are some good signs, he [Abe] bit the bullet by overcoming fierce opposition by the farm lobby to agree that Japan will enter the Trans Pacific Partnership [talks]," Mitsui said referring to the U.S.-led trade negotiations with Asia Pacific economies.

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