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Are Japan's stocks still ready to rumble?

Leslie Shaffer | Writer for CNBC.com
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Japan's shares have surged around 45 percent so far this year, but some analysts are forecasting the rally may continue throughout 2014 despite concerns the country's economy will remain stalled.

Around a year on from when Japanese Prime Minister Shinzo Abe voiced the need for radical change to kick-start Japan's moribund economy, analysts remain divided over the success of "Abenomics." In addition, many remain concerned Japan's rapidly aging and shrinking population will continue to weigh on economic growth.

But some remain bullish.

(Read more: More signs of Japan rebound: Exports soar)

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"This notion of the decline of Japan is kind of overdone. This is a fantastically productive economy in general. They have a demographic issue of course. It's not the only country in the world with a demographic issue," said Nicolas Rohatyn, CEO of Rohatyn Group, which has more than $7 billion under management, at the AVCJ Asian Private Equity & Venture Forum in Hong Kong last week.

(Read more: Reforms to shift Japan's huge pension fund towards riskier investments)

"Low GDP (gross domestic product) growth is a problem, for sure, but it's not the whole picture."

Data last week showed Japan's GDP grew 0.5 percent in the third quarter from the previous one, slowing from a 0.9 percent expansion in the April-June period amid weakness in exports and as consumer spending eased.

Despite mixed economic data, some analysts are predicting another bull run in the market.

"The Japanese economy is just one step away from a virtuous cycle (corporate earnings growth leading to increased capex, resulting in wage hikes, supporting higher consumer spending, then back full circle to corporate earnings growth)," said Kazuhiro Miyake, Daiwa's chief Japan strategist, in a note. He expects wage talks between the government, labor and management in December are highly likely to hammer out salary increases and trigger the cycle.

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"Japanese shares tend to be closely correlated with the medium-term and long-term business cycles," he said. "In periods when private-sector investment, particularly capital expenditures, accelerates, the Tokyo stock market typically stages a long-term bull run," he said. If capex and construction investment expand through the early 2020s, shares could have a long-term "revitalization" rally through 2020, he said.

(Read more: Why Japan stocks may storm higher even if the yen firms)

Tokyo was chosen to host the Olympic Games in 2020, spurring expectations of increased infrastructure investment.

Miyake expects the Nikkei 225 index to reach 16,400 by the end of March and 18,000 by the end of December, while the Topix index may target 1360 by end-March and 1380 by end-June and 1490 by end-December. The index targets through June are based on a price-to-earnings ratio of around 14 times 12-month forward earnings, around the current level. The Nikkei is currently trading around 15,100, while the Topix is around 1234.

He expects corporate earnings forecasts could be raised as Japanese firms beat forecasts by a wide margin in the July-September quarter, but analysts mostly have not adjusted their estimates.

Nomura also expects a 2014 rally in Japan's stocks. It expects the Nikkei to hit 16,000 by the end of March, slip to 15,000 by the end of June and then climb to 18,000 by the end of December. It expects the Topix index at 1500 by the end of 2014.

(Read more: Japan's economic growth slows in Q3)

"In the first half of the year, we expect stocks to rally as improvement in supply and demand conditions are joined by expectations for monetary easing," the bank said in a note.

"As the middle of the year approaches, we think stocks will tend to correct as concerns over the adverse effect on corporate earnings of the consumption tax increase (set for April) are priced in," Nomura said in a note. But in the second half, it projects stock valuations will head for 15 times estimated forward earnings, with Nomura expecting the introduction of additional monetary easing around that time.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1