Nikkei Sees 6.65% Gain So Far in May, Can it Hold or Will it Go Away?

Recently, Nikkei traded at highs not seen since 1990 after gaining 6.65% in May, opening hopes that it might finally recover its peak. However, there are some warning signs.

Accelerating the Trend

Japan's blue-chip index had a stellar performance in 2023, gaining more than 20% since the start of the year as it picked up more steam at the start of May, when most Japanese stocks reported earnings and beat estimates overall. The substantial growth among listed firms helped boost stocks but also revived hopes that executives could revert a practice that has contributed to weakness in Japanese stocks for years.

Companies have been reluctant to share earnings with investors due to relatively high corporate taxes in Japan and general economic uncertainty, albeit the latest GDP figures have suggested a rebound in growth. Additionally, a weaker yen over the last year has helped exporters generate more profits, while foreigners have found it cheaper to access Japanese capital markets.

Continued Help from BOJ

The new BOJ Governor Kazuo Ueda's insistence on keeping easing in place despite inflation doubling the bank's target makes Japan unique among major economies in raising rates to fight inflation. The central bank sees Japan's recent bout of inflation as driven by external price shocks and is not linked to sustained economic growth. On the other hand, investors see the situation differently and are piling into the stock market in anticipation of increased profits from Japanese firms.

While the government touts the recently agreed large wage rises, real wages have fallen the most since 2014, which is far from being a wage-price spiral that might push the central bank to hike. Trade has slowed, with both imports and exports lower than in the same time last year, when Japan's largest trade partner, China, was facing lockdowns due to covid. The recent bump in corporate earnings, and therefore the Nikkei, might be short-lived if underlying economic indicators don't improve. Perhaps that's why Governor Ueda insists on "sustainable" inflation and refuses to budge on easing.

Nikkei Breaks Out of Triangle

Japan's top 225 stock index broke outside a long-term triangle pattern in late April, retested the upper trendline in early May and shot higher, riding a wave 31360. Typically, triangle breakouts lead prices to the measured-move target, around 34220. Notably, this is around the same level as the 161.80% reverse Fibonacci of the triangle's opening range, with 138.2% shy of the 33k threshold in focus. On the way up, the 30000 round support will be a critical level for future price action, as its breakdown will expose the swing of 29250 and the triangle breakout low of 28500. Sliding lower could signal the end of the upside, with 26450 acting as a last resort for bulls.

Key Takeaways

Nikkei has been trading at highs not seen since 1990 due to the substantial profit growth among listed firms and a weaker yen. Earnings reports have boosted stocks and revived hopes that executives could revert a practice that has contributed to weakness in Japanese stocks for years. However, real wages have fallen despite the government agreeing to large rises, trade has slowed lower than the prior year, and underlying economic indicators don't improve, which may explain Ueda's persistence in easing despite inflation rising, as BOJ believes it is driven by external sources.