Bullish momentum expected to continue for Nikkei 225

THE Nikkei 225 Mini Futures contract, which represents the performance of 225 publicly-owned Japanese companies, has been one of the best performing stock indices this year. The contract previously crossed above the 33,000 level for the first time since 1990, reaching a high of 33,960 on Jun 19, 2023. However, is the year-to-date rally sustainable, or will it be a repeat of 1989/1990 when the stock market reached all-time highs before slumping into a three-decade economic stagnation?

We hold a bullish outlook on the Nikkei 225 Mini Futures contract as we think the YTD outperformance of Japanese equities will be sustainable due to a multitude of structural tailwinds. We forecast the contract to see a slight correction in the near term due to a global growth slowdown although it should be relatively shallow as we see the contract heading towards the 38.2 per cent retracement level of 31,465 – 31,500. We also expect the contract to recover and head towards resistance (R1) at 33,960 – 34,000 by the end of 2023. If broken, the contract should head further towards the August 1989 high of 35,192 – 35,200 (R2).

Fundamentally, we think the outperformance of the Nikkei 225 is sustainable given: 1) Japan’s long-awaited exit from deflation, 2) the Bank of Japan’s (BOJ) ultra-easy monetary policy, 3) corporate reforms by the Tokyo Stock Exchange (TSE) aimed at driving improvements in return on equity and shareholder returns, 4) Warren Buffett’s endorsement, and 5) Japan as a likely beneficiary of supply-chain diversification and “friend-shoring” amid US-China tensions. In our view, these factors appear more structural in nature and are unlikely to be short-lived.

Japan’s nationwide Consumer Price Index (CPI) excluding fresh food and energy rose more than expected by 4.3 per cent year on year in May 2023, signalling that the country is finally exiting from deflation. This revival of inflation should help boost corporate margins as firms look to raise prices to offset higher costs. At the same time, this exit from years of deflation will discourage people from hoarding cash, and encourage them to put their money in stocks instead, as the value of their cash/deposits will only decline due to inflation. Inflation momentum is likely to be accompanied by an increase in wages. Japanese firms have agreed on the biggest wage hike in 30 years. Therefore, inflation dynamics appear to be sustainable.

In contrast to the rest of the world, the BOJ’s ultra-easy monetary policy should be supportive for equities. The BOJ left its monetary policy and yield curve control (YCC) unchanged at the Jun 16 meeting despite speculation that there might be a policy pivot or tweaks to the YCC as the yen weakens further. We believe the BOJ will maintain its ultra-easy monetary policy as the benefits of sustained price growth outweigh the downsides of a policy pivot. We only see a potential pivot happening after the BOJ finishes its 18-month review.

At the start of the year, the TSE released guidelines emphasising shareholder returns. We expect to see more firms using their huge cash stockpiles to buy back shares and raise the price to book ratio. Since the reforms, roughly one-third of TSE-listed stocks have announced measures to increase shareholder returns. We anticipate more firms announcing share repurchases and higher dividend payments, all of which should be supportive for equities.

Buffett, the Oracle of Omaha, also grabbed headlines after he increased stakes in Japan’s five biggest trading houses - Mitsubishi, Mitsui & Co, Sumitomo, Itochu and Marubeni.

However, Japan is still exposed to external risks such as a global economic slowdown which could spark a short-term equity correction due to weak export demand. Thus, we anticipate a near-term correction in 2H 2023 as the global macro backdrop becomes more challenging.

On a technical perspective, we see that the contract has broken below the floor of its medium-term uptrend channel. The Relative Strength Index (RSI) is still in bullish territory at around 58. We hold the view that the contract has further upside before hitting the overbought level of 70. As long as the RSI remains above 50, we think the bullish momentum remains intact.

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The contract is trading above all three key moving averages (50, 100, 200) which typically signal a bullish momentum.

In closing, we hold a bullish outlook on the Nikkei 225 Mini Futures contract, supported by structural fundamental tailwinds. The contract may see a near-term decline towards support at 31,465 – 31,500 (S1) due to a global growth slowdown. However, the slowdown should be relatively mild and we forecast the contract to end 2023 at 33,960-34,000 (R1). If the bullish momentum persists, the contract may hit the August 1989 high of 35,192 – 35,200 (R2).

The writer is investment analyst at Phillip Nova