Is the Nikkei in for a pullback?

Japan ‘s Nikkei (Nihon Kenzai Shinbun: .N225) powered to fresh 15-year highs over the past week amid a handful of macro and micro factors, and while the uptrend looks set to continue, investors should brace for a near-term pull back, analysts say.

“Stock prices rose so quickly in such a short period of time that they may be in for a correction in the short-term,” said Bank of Tokyo Mitsubishi UFJ (BTMU) senior market economist Toshiyuki Suzuki.

The Nikkei has gained 3.4 percent over the past five days, closing at 18,603 on Tuesday – its highest close since the height of dotcom bubble in 2000. On Wednesday, the index closed the morning session 0.14 percent higher.

“It’s been a volatile week but a combination of macro and micro factors were also behind the recent rally – concerns over a Greece crisis eased, while Japanese exports and corporate earnings have been rising,” said Daiwa (Tokyo Stock Exchange: 8601.T-JP) Securities senior Japan equity strategist Takuya Takahashi.

Rally likely to continue

Investors need not fret over a pullback, according to BTMU’s Suzuki.

The rally should resume because “Abenomics is boosting corporate profits and investors are hoping for positive surprises when the full year earnings come out in May,” he said.

Indeed, Japanese stocks have been on a roll since Prime Minister Shinzo Abe returned to power in 2012, promising to put an end to deflation and get the economy growing again.

The so-called “first arrow” of his economic policies, dubbed Abenomics, was unprecedented monetary easing, which added fuel to the blossoming stock rally. The Nikkei has doubled in value since December 2012.

Both BTMU’s Suzuki and Daiwa’s Takahashi anticipate further gains and see the Nikkei at 20,000 by year end.

Weaker yen boost

The Bank of Japan (Tokyo Stock Exchange: 8301.T-JP)‘s (BOJ) successive quantitative easing measures have also sharply weakened the yen. The Japanese currency is 47.5 percent weaker than November 2012, the month before Abe was re-elected.

That not only boosts profits at Japan’s blue-chip exporters, who are heavily weighted on the benchmark Nikkei index, it also makes Japanese stocks look relatively undervalued, said analysts.

Read More Is the Nikkei rally unstoppable?

“For foreign investors, the weaker yen makes Japanese assets, such as stocks, still look relatively undervalued in dollar terms,” said BTMU’s Suzuki.

In dollar terms, the Nikkei has gained 31 percent since January 2013, according to a Daiwa research note published on Tuesday. During the same period, the benchmark index has gained nearly 80 percent in yen terms.

Bubble concerns

A huge shift towards Japan stocks by the public pension fund, coupled with measures from the BOJ has further underpinned the rally, but those gains have raised concerns among some analysts.

In October, the BOJ said it would triple annual purchases of Exchange Trade Funds and Japanese real-estate investment trusts. In January alone, it spent 344 billion yen ($ 2.89 billion) on ETFs, according to central bank data.

Meanwhile, Japan’s Government Pension Investment Fund (GPIF) doubled its domestic stock allocation to 25 percent; many private sector pension funds are benchmarked to the GPIF.

The combined flood of liquidity, from “overseas investors and the artificial floor set by the GPIF and the BOJ, which buy on any dip” have helped Tokyo stock markets perform well, said Mizuho Securities’ chief market economist Yasunari Ueno.

However, that has raised concerns the Nikkei is in bubble territory.

“The fundamentals don’t support the prices anymore,” said Mizuho’s Ueno. “Stock and bond prices cannot rise together for long if the market are behaving normally and pricing in fundamentals,” he said. In a “normal” market, positive economic data would prompt investors to buy stocks and sell bonds, he pointed out.

But of late, investors have been buying stocks and government bonds: the yield on the 10-year Japanese government bonds have fallen by 8.29 percent over the past five days, to 0.375 percent. Bond yields move in inverse to the price.

Exceptional monetary easing may have pumped a lot of money into the financial markets and lifted prices, “but only monetary tightening can pop the bubble – and there is no sign of any tightening on the horizon,” said BTMU’s Suzuki.

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