Nikkei Hits 10% Monthly Gain, But Risks Remain

Can equity valuations finally normalise after the Nikkei hit a fresh high not seen in 35 years?

More Record Highs Ahead?

The Japanese benchmark, the Nikkei 225, exceeded its 1989 peak on February 21 to reach a new 35-year high. This came after the index gained 10% in February, continuing the strong performance seen throughout 2024. Attractive relative valuations have driven the rise compared to other major markets, with significant investment flows redirected away from China towards Japanese equities.

Some observers have drawn comparisons to the 1980s bubble, which saw sky-high real estate prices alongside an overheated stock market. However, current valuations appear reasonably priced relative to earnings growth. Japanese firms have also delivered robust quarterly earnings results in recent years.

While the underlying fundamentals appear firmer than past occurrences, maintaining the upward trajectory still faces risks. A major supporting factor has been foreign investment attracted by the weak yen. Nevertheless, the Bank of Japan (BOJ) has signalled that its extraordinary monetary easing is nearing an end, which could strengthen the yen and dampen inbound flows. Although valuations seem normalised, volatility cannot be ruled out as policy adjustments come into effect.​

The Broader Market Support

Unlike in the US, where gains have been driven predominantly by a small number of technology companies, the rise of the Nikkei 225 has stemmed from a more diverse range of firms. This has helped to alleviate concerns around a lack of participation across sectors. Indeed, renowned value investor Warren Buffett was one of the early proponents of the Japanese equity rally and has given no indication of reversing his position.

The recent momentum for Japanese stocks has coincided with the nation entering a technical recession in the second half of last year, losing its status as the world's third-largest economy. However, market participants point to wider regional dynamics that could see growth in Japan more resilient through periods of volatility. Geopolitical risks in China have also made Japanese equities a relatively attractive investment proposition. While the BOJ is set to normalise policy rates out of negative territory, it also emphasises that any subsequent tightening will be very gradual, allowing the market to steer short-term turbulence somewhat orderly.​

Nikkei Faces Fibonacci Resistance

Japan 225 has overtaken 40K; however, it now faces technical resistance at the 61.80% reverse Fibonacci retracement level of 30700-15600 leg. Encouragingly, the overall trend has accelerated further since breaking above the upper channel. If the index remains above this trendline, 41K and subsequent round levels could be targeted in the near future. Conversely, a breakback below this trendline support would leave 37K exposed initially, with 35300 acting as the next level of potential support.

Source: SpreadEx / Japan 225

Key Takeaways

Nikkei 225 reached a 35-year high following a 10% gain just in February alone and strong performance throughout the year. Attractive valuations largely drove the move in relation to other major markets as significant investment flows redirected away from China. While underlying fundamentals appear sounder than before, maintaining the trajectory faces risks. A major factor has been foreign investment attracted by the weak yen. However, as the BOJ signals an end to negative policy, the yen could strengthen and dampen inbound flows.