Is the Nikkei Getting Its Mojo Back?

People walk past an electric quotation board flashing the Nikkei key index of the Tokyo Stock Exchange (TSE) in front of a securities company in Tokyo.
Toru Yamanaka | AFP | Getty Images
People walk past an electric quotation board flashing the Nikkei key index of the Tokyo Stock Exchange (TSE) in front of a securities company in Tokyo.

Japanese stocks, which hit a new one-month high on Tuesday, appear to have got their mojo back, putting the 15,942 mark - a five-and-a-half year peak - within shooting distance.

The Nikkei's seemingly unstoppable winning streak came to an abrupt end in late May and it lost some 20 percent in the weeks up to June 17. Even after that it has seen heightened volatility, but positive economic data since last Thursday have prompted a near 9 percent rally.

"Of course we are back on an upward trajectory," said Nicholas Smith, Japan strategist at research house CLSA. "I think the five-and-a-half year high is definitely back in sight, there is still 20 to 30 percent room for growth in the market."

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Japanese equities soared over 80 percent since mid-November to late May, after Prime Minister Shinzo Abe first unveiled his radical economic plan to revive the country from 15 years of deflation.

The pullback raised some concern that the turnaround story has lost some of its luster, but analysts said the correction was nothing to do with a change in sentiment, but in part a result of fears over the tapering of the U.S. Federal Reserve's stimulus program.

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"The Japanese market was not over-valued, it was over-heated. The market was looking for an excuse for a pullback or a clean out and the 'taper tantrum' worked to trigger that," said Smith.

Recent positive data showed that Japanese manufacturers moved into positive territory for the first time in nearly two years last quarter, while industrial output and retail sales data for the month of May broadly painted a picture of an economy in recovery.

Makarim Salman, Japan equity strategist at global investment bank Jefferies, also sees Japanese stocks on an upward trend, but said investors need to be prepared for further volatility.

"We see the Nikkei as generally on a bullish trajectory, but the yen and the political environment will play a key factor in how fast it will rise higher," he said.

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The yen has lost 25 percent against the U.S. dollar since mid-November, weakening past the psychologically important 100 level for much of May. But in recent weeks the yen has show some renewed strength, returning to levels of around 94 to the dollar in mid-June. On Tuesday it was back trading at around 99.5 to the dollar.

Besides following the yen, investors will now be looking ahead to the next risk event in Japan which will be the elections to the upper house of parliament on July 21. If Abe gains a majority in the elections, he should be in a stronger position to push through structural reforms.

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"This is the one chance to get back, you won't get a chance like this again,"CLSA's Smith said, referring to buying into the Nikkei.