Japan’s stock markets continue to test new highs. Is the rally sustainable?

Japanese stocks have been on a stellar run in 2024.

In February, the country’s standard Nikkei 225 hit its 1989 level.

This week, the broad-based Nikkei and Topix surpassed previous records to hit all-time closing highs on Thursday. Topix has significantly broken a 34-year-old record set in December 1989.

How did the markets get to these levels, especially for the Nikkei, which has hit new highs for the second time this year?

Earnings are the only driver of the current market rally, Jesper Koll, director expert at Tokyo-based financial services company Monex Group, told CNBC.

“Corporate Japan is now benefiting from decades of operational restructuring,” Koll said, adding that “breakeven points are at world-record lows, so even minimal increases in top-line revenue are fueling explosive profit growth. “

It predicted earnings growth of 35% over the next two financial years – from April 2024 to March 2026 – as well as growth of 4% a year.

His predictions stem from a forecast that Japanese companies will see domestic and global sales growth, and he explained that his forecast for a 4% sales increase is due to wage increases announced by Japan’s largest labor union. on Thursday.

Japan’s largest union, commonly called Rengo, announced that Japanese companies have made the biggest wage increase in 33 years this year.

Monthly pay for union-backed workers will rise an average of 5.1% this fiscal year ending in March 2025. Rengo also said that large firms with 300 or more union-backed workers saw wage increases of 5.19%, while smaller firms small increased wages by 4.45%.

“You don’t have a shunt [wage hike] of 5% and nominal sales increase less than 4%, for example”, he emphasizes.

More importantly, Koll said, Japan is a “bastion of stability.” He emphasized that its monetary, fiscal and regulatory policies are stable and pro-growth, and this serves as an important support for financial markets.

When the Nikkei passed 40,000 in March, Koll told CNBC at the time that it was “very reasonable” for the index to break 55,000 by the end of 2025.

Koll told CNBC this week: “I stand by my prediction — the Nikkei 225 is poised to rise to 55,000 before the end of next year.”

If his prediction comes true, it would be a 37% increase from the 40,000 figure.

Earlier, Koll had predicted that the Nikkei would pass 40,000 in the twelve months from July 2023. He was later proved right when the index reached that level within eight months.

However, the million dollar question will be: how long can this rally last?

A note from Nomura, published on Thursday, said gains in the Nikkei and Topix do not look sustainable. Analysts identified that these were caused by short covering in the future.

However, there is a caveat.

They said “these rushing gains could prove durable if it starts to look likely that April-June corporate earnings will surprise higher or that the Japanese equity market will see more long-term cash inflows.”

In the near term, Nomura said futures contracts will have “a lot to say” about stock movements in Japanese stocks, noting that as of June 28, net short interest of foreign companies securities in the future reached 17,000 contracts.

If those short positions were to be undone, Nomura estimates the Topix would see a rise of about 2% to 3% from June 28 levels. According to their calculations, it will put the Topix at around 2,875 and the Nikkei 225 at around 40,600.

Since then both indexes have outperformed Nomura’s estimate, though not by much.

“We will be watching to see if Japan-listed domestic equity investment trusts and US-listed ETFs (which have seen outflows) start to see inflows,” Nomura analysts said.

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