The Japanese stock market has experienced a remarkable ascent in recent months, fueled by various factors that have piqued the interests of global investorsAs of January 18, 2024, the Nikkei 225 index stood firm at 35,465 points, sitting tantalizingly close to the historical high of 38,951 points set back in 1989. This resurgence is particularly notable as it comes on the heels of a period when the Japanese yen has fallen against the U.Sdollar, thereby boosting export profits for Japanese companies relying on international customers.

Since 2023, the Nikkei 225 has rallied impressively, witnessing a growth of nearly 30% throughout the year, with a further gain of approximately 7% in the beginning months of 2024. This remarkable performance has contrasted starkly with the fortunes of stock markets in Europe and the U.S

The culmination of the previous year saw the index surpass the pivotal 35,000-point mark—an achievement not witnessed in many years and a substantial indicator of market vitality.

Numerous contributors have played a role in this market revival, notably the endorsement of Japanese equities by famed investor Warren BuffettHis bullish stance has catalyzed a rush of foreign investment eager to bask in Japan's economic revitalizationFurther underlying factors include geopolitical improvements related to increased international collaboration in semiconductor manufacturing, pivotal governance reforms in the Tokyo Stock Exchange (TSE), a prolonged loose monetary policy, and the influence of a depreciated yen—all working in concert to bolster stock prices.

Investment forecasts for Japanese equities have leaned toward the optimistic, with various financial analysts predicting the Nikkei could range between 36,000 and 39,000 points by the year's end

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Though optimism prevails, caution remains warranted as adjustments could occur should signs of overextension manifest, particularly as the index hovers near 36,000 points.

The emerging “blossoms” of the Japanese stock market

Investor enthusiasm has surged in response to the Nikkei 225’s breach of a 34-year high, augmented by growing profits among exporters thanks to the yen's weakened stateThis positive shift aligns with concerted efforts aimed at enhancing shareholder returns through corporate governance reforms, presenting an appealing technical backdrop to potential investors.

The TSE has actively addressed concerns regarding underperforming stocks with a price-to-book (PB) ratio below one, urging these firms to enhance shareholder communications regarding improvement strategies

This focus on shareholder value underscores the growing necessity for companies to prioritize financial transparency and accountabilityNotably, international investors have been underrepresented in Japanese equities; therefore, a recalibration of investment portfolios pointing toward Japan may be inevitable amid the current inflow of capitalThe yen’s decline further enhances the attractiveness of Japanese exports, especially in the burgeoning tourism and service sectors.

On January 15, 2024, the TSE released a list disclosing which companies were actively pursuing reformsThe Japanese market is categorized into three segments: Prime, Standard, and Growth marketsAs of March 31, 2023, the TSE mandated that companies listed on the Prime and Standard markets take measures concerning capital costs and share price management.

The TSE's documentation highlighted that 660 out of 1,656 firms in the Prime market had presented plans aimed at improving capital efficiency, including major corporations like Sony and Panasonic

Furthermore, 155 companies were under review, while a staggering 841 firms had not reported any improvementsStarting in 2025, the TSE will also require publicly listed firms to disclose information in English, with progress monitored closely.

Current valuation metrics suggest that the Nikkei 225 is trading at a price-to-earnings ratio of 17.1, which is below the average over the past three, five, and ten yearsMeanwhile, the net profit of Japanese publicly listed companies has experienced a robust annual growth of 31% over the last three years, vastly outpacing the revenue growth rate of 9.5%. This disparity signals a bullish sentiment among investors who view Japanese equities as an attractive avenue given their relatively cheap valuations, strong profitability, and generous dividend yields.

Data from the TSE indicates that in 2023, foreign capital saw a cumulative net inflow of approximately 6.3 trillion yen (about $43.9 billion) into Japanese stocks, marking the highest level since 2014. This influx is particularly appealing for investors looking to mitigate inherent risks within the concentrated U.S

stock market or those searching for alternative emerging market exposuresThe stocks actively engaging in corporate governance reforms, particularly in sectors like semiconductors and consumer recovery themes, appear poised for further examination.

Short-term market pressures evident in Japanese equities

Despite the current bullish conditions surrounding the Japanese stock market, there are evident signs of overbuying leading to potential downward pressuresRecent readings on the Nikkei’s Relative Strength Index (RSI) have indicated overbought conditions, suggesting a possibility of imminent market correctionsIndeed, instances of RSI reaching extreme highs often precede notable reversals, raising concerns among analysts.

In the short term, the Nikkei has exhibited overbought signals across various timelines, emphasizing the suddenness of this recent market upswing

Notably, the RSI for shorter durations has entered the 80 territory, indicative of potentially unsustainable momentumHistorical data reveals a pattern whereby overbought conditions on the four-hour charts have frequently marked short-term peaks, prompting a closer scrutiny of potential corrections.

Considering potential catalysts for significant market shifts, the narrowing yield gap between U.Sand Japanese bonds is crucialConcerns abound regarding future Federal Reserve rate cuts and impending Bank of Japan interest rate hikes, which could catalyze strength in the yen, culminating in adverse effects for the stock market.

Moreover, for Chinese investors contemplating exposure to Japanese stocks via index ETFs, the premium rates present additional risksFor instance, on January 16, the Nikkei 225 index dipped by over 0.8% during the session, while Chinese ETFs continued to perform strongly, like the Huaxia Nomura Nikkei 225 ETF, which soared nearly 7% at one point

The premium for these funds approached 20%, only to decline by the session's end; however, a closing premium near 10% suggested investors would be paying a premium, which could exacerbate losses.

The yen's depreciation continues to provide a cushion for the Nikkei's strength

The current resilience of the Japanese stock market can also be attributed to the recent rebound of the dollar, which has come at the expense of a weakening yenThis dynamic has facilitated the Nikkei's maintenance of its upward trajectory.

The U.Sdollar against the yen has surged to new highs for the month, nearing 148, bolstered by rising Treasury yields which have expanded the interest rate differentialThe yen's depreciation has effectively propelled the Nikkei index to reach its 34-year heights.

However, future shifts in the yen's strength relative to the dollar warrant close attention

This is particularly pertinent as a look towards recent trends suggests that the dollar/yen is inclined toward a possible downturn, signaling yen appreciationRecently seen peaks in dollar/yen valuations were spurred by modest adjustments in interest rate expectations, with the four-hour RSI suggesting potential exhaustion of upward momentum.

Market technical indicators, such as the relative strength index, are signaling caution at these valuation levelsAlthough past performance does not guarantee future trends, the prevailing configurations suggest that reversals at these junctures are uncommon.

In the forthcoming period, decisions by the Bank of Japan regarding monetary policy will be crucialAlthough earlier market sentiment leaned heavily toward expectations of imminent rate hikes, recent adjustments have tempered those predictions.

Despite the Bank of Japan signaling intentions to scale back its bond-buying spree, the aftermath of a significant earthquake in early 2024 has intensified expert opinions around the prolongation of negative interest rate policies

Recent data indicating a dip in Tokyo’s CPI in December 2023 alleviated some pressures on the central bank.

Latest statistics further revealed that Japan's nominal wages grew by merely 0.2% year-on-year in November 2023—significantly below the anticipated growth of 1.5%. These figures indicate that real wage growth has dipped consistently for 20 consecutive months, with persistent wage growth seen as a prerequisite for any rate hikeCurrent market indicators suggest that the first potential increase could occur in July 2024, a revision from earlier anticipations of April, which in turn contributed to the dollar's resurgence against the yen and the continued upward pressure on the Nikkei 225 index.

At present, the dollar/yen has surged past the vital threshold of 147.40, inching towards 148, with prospects for further ascent to 148.30, a point of mild resistance observed in early December

Given recent historical context and skepticism toward a further widening of the interest rate differential, a cautious view favors a short position (betting on a yen rebound). Nevertheless, this does not come without uncertainty, as prior market assessments of the Federal Reserve's rate cuts may have been too aggressive.

Nikkei finds itself in a temporary lull below 36,000

Looking ahead, the potential for the Nikkei 225 index to break through the 36,000-point barrier remains a focal point of attentionHowever, recent bullish sentiment regarding the Nikkei appears to have given way to a notable retreat, following its recent 34-year peak achieved on Monday, January 15.

Whether driven by new geopolitical risks or skepticism toward the market's priced-in rate cuts, cyclical assets are beginning to experience strains

Factors including hawkish commentary from Federal Reserve officials have further dampened the dollar's weakening trajectory and shelved the risk appetite, affecting the performance of risk assets like the Nikkei index.

The hawkish comments made by Federal Reserve Governor Chris Waller on Tuesday served to deflate the previously buoyant market atmosphereHis remarks quashed the index and propped up the dollar anew, leading to a slight dip in market sentimentAs a result, the probability of a rate cut in March has fallen from around 80% over the past weekend to just 63% now.

What does Waller's hawkishness entail? He indicated that three rate cuts are appropriate as opposed to the six anticipated by the marketWaller expressed greater confidence that the Federal Reserve is close to achieving a sustainable core PCE inflation rate of 2%, reinforcing guidance around future monetary policy adjustments.

In the short term, the upward momentum of the Nikkei appears to have stalled, with the index vulnerable to recording its first pair of bearish candlesticks on the four-hour chart in over a week