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Nikkei at 25,000? Nomura thinks so

The Nikkei may have just finished its best year since 1972, but its best days aren't behind it, Nomura said, making the market its top global pick.

"Japanese equities will provide the greatest return of all global stocks in 2014," Nomura said in a note.

It's a big call after a big year. The Nikkei ended its final trading session of 2013 on Monday at 16,297.31 points, up 53.7 percent for the year, its best gain since 1972.

(Read more: Yen set for worst year since YMCA topped the charts)

After waning risks and higher stock valuations pushed up shares globally this year, Nomura now expects earnings increases to be the key driver in 2014.

"We forecast earnings per share (EPS) growth of 19 percent for Japanese equities in 2014, the highest of all, followed by European equities at 14 percent," it said.

Nomura forecasts the index will rise to 18,000 by the end of 2014, based on 15 times earnings. But the forecast assumes the U.S. dollar will be fetching 100 yen, compared with current levels around 105. For every 1 yen that the U.S. dollar ticks up, the Nikkei will rise by around 377 points, Nomura estimates.

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"Further yen depreciation would increase upside," it said.

The bank doesn't expect the gains to stop there, predicting the index could touch 25,000 in 2018 if Abenomics – a series of policy measures unveiled under Prime Minister Shinzo Abe in late 2012 to jump start the economy – proves successful.

If the ruling party's pledge to achieve nominal gross domestic product (GDP) growth of at least 3 percent appears more realistic, it could increase medium-term EPS growth to around 15 percent, from around 10 percent.

(Read more: Buy Japan exporters on weak yen? Not so fast)

Japan's GDP growth has barely breached 2 percent over the last decade and deflation has plagued the country for 15 years.

In addition to earnings, Nomura sees two other potential drivers for Japan's stocks.

The country's individual investors may step up stock purchases with the January start of tax breaks for the tax-free investment accounts dubbed NISA, for the Nippon Individual Savings Account. The accounts offer a five-year tax holiday on dividends and capital gains, provided the funds are invested in stocks, mutual funds or exchange-traded funds, with bonds not eligible for the tax breaks.

"It will trigger a 'great rotation' in financial assets," Nomura said, noting as of October the National Tax Agency received 3.58 million applications for NISA accounts, suggesting a rapid takeup. It expects around 1.3 trillion yen, or around $12.4 billion, could flow into equities.

If around 1 trillion yen a year flow into Japanese equities, share prices could rise by around 5.2 percent a year, it said.

(Read more: Place your bets: China or Japan?)

The second new driver for the market will likely come from the Government Pension Investment fund increasing its weighing in Japanese equities, Nomura said, adding it expects the new weightings to be decided by the middle of 2014.

To be sure, Nomura expects stocks to suffer a mid-year hiccup.

"Stock prices may well be weighed down by concerns that the consumption tax rate hike will dent earnings and the disappearance of expectations that the Bank of Japan will implement additional monetary easing," it said.

(Read more: HSBC strategist: Am I the last person in the world underweight Japan?)

In April, Japan's consumption tax is slated to be raised to eight percent from five percent. The hike is expected to dent consumer spending, hurting corporate earnings.

The market expects the Bank of Japan will ease monetary policy further in the April-to-June period, according to a Nomura survey of institutional investors in November, but the bank thinks the easing likely won't come until around July.

"If the market expects easing in April but none takes place, this negative surprise could dent the market for a time," it said, forecasting the index may slip to around 15,000 mid-year, before spiking higher.

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

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