Wall Street sees further upside for Japan stocks as they notch a fresh three-decade high

With Japanese stocks suddenly back en vogue with global investors, analysts at top Wall Street investment banks are predicting more upside for the country’s benchmark indexes.

Japan’s Topix (Tokyo Price Index) has marked new peaks in the past two weeks, seeing its highest level since July 1990 on Monday.

It’s notched a 14% jump since the beginning of this year, most recently fueled by optimism from a tentative debt ceiling deal reached between U.S. President Joe Biden and House speaker Kevin McCarthy, alongside a boost from a weakening yen. Meanwhile, the Nikkei 225 has rallied further, having gained some 20% year-to-date.

Goldman Sachs strategists wrote in a Monday research note that foreign investors’ positioning on stocks in Japan is still underweight.

“Whereas we believe positioning is stretched among short-term investors such as CTAs (Commodities Trading Advisors), positioning is still light among foreign long-term investors,” strategists Kazunori Tatebe and Bruce Kirk said.

They added that they see Japan stocks benefiting from “structural changes” in the economy. A restructuring of corporate governance rules by the Tokyo exchange, aimed at improving shareholder returns, is also widely seen as giving stocks a leg higher.

“Given this large underweight and light positioning, we see potential for further large-scale inflows into the Japanese equity market in the event that steady progress with structural changes/reforms strengthens the confidence of foreign long-term investors,” the Goldman analysts said.

“If progress is made in accordance with investor expectations, Japanese stocks could see a prolonged advance over the medium term, and we continue to see risk to the upside for Japanese stocks,” they added. Strategists at Goldman Sachs see the Topix reaching 2,200 points by the end of the year, or a 3% rise from current levels.

Bank of America strategists Masashi Akutsu and Tony Lin added in a research note last week that they see scope for further overseas inflows to cash equities — raising their year-end forecasts for Japanese indexes.

“We believe the continued buyback momentum this year, coupled with the potential overseas inflows to cash equities similar to 2013, will likely sustain the market rally for the rest of year,” they said. Buybacks are when firms purchase back their own shares to increase scarcity, thus increasing their price.

BofA strategists see the Topix rising to 2,300 points, an additional 7% gain from current levels, with a bull case for it to rise even further to 2,400 points. They also see the Nikkei 225 rising to 32,500 points, an additional 4% from levels seen on Tuesday morning – with a bull case for 33,500 points.

“If an inflationary regime becomes entrenched and companies can achieve double-digit ROE [return-on-equity], this would bring a return to the 1989 high within reach,” they wrote, noting that the Topix’s 12-month forward ROE stood at 8.8% last week. Return on equity is a gauge of a company’s profitability, measuring a firm’s net income divided by its shareholders’ equity.

“Japanese stocks have not risen out of step with fundamentals, and we see further upside as long as earnings continue to improve,” they wrote.