Memories of the first year of the Heisei era come flooding back! The unstoppable bull market in the Japanese stock market is getting closer and closer to the historical high point of 1989.

Can the most popular stock market in Asia, the Japanese stock market, set a new historical high with the help of an incredibly strong inflow of foreign capital? There is no shortage of investment institutions voicing their support for the long-term bullish trend of the Japanese stock market, but voices of short-term bearishness are gradually emerging. As the Tokyo Stock Exchange's benchmark index, the TOPIX, enters overbought territory, sell signals are starting to flash in the short term. In addition, speculation about the Bank of Japan's policy may lead to increased volatility in the yen, putting short-term pressure on Japanese stocks. Nevertheless, the majority of investment institutions remain optimistic that the Japanese stock market will continue to rise with the assistance of foreign capital inflows, eventually breaking through historical highs.

According to a recent survey conducted by Bank of America, global investors' enthusiasm for Japanese stocks far surpasses that for other Asian stock markets. In the Asian region alone, 59% of Asian fund managers choose to increase their holdings of Japanese stocks, while the Indian stock market lags far behind at only 18%, ranking second. The basis for this optimism lies in the fact that Japan's two major benchmark indices, the Nikkei 225, which is based on blue-chip stocks, and the broader TOPIX, have reached their highest levels in 34 years, approaching the historical high set during the Japanese bubble economy in 1989, the first year of the Heisei era. Furthermore, the continuous weakening of the yen and Japan's sustained return to inflation provide further support for this optimistic outlook.

However, the excessively bullish sentiment in the market towards the Japanese stock market has raised doubts among two major investment institutions. Strategists from HSBC Holdings Plc and Societe Generale SA recently emphasized that the Japanese stock market has risen too high and investors should consider taking profits in the near term. The volatility of the yen has become another cause for concern, as the weak trend of the yen is driven by the country's negative interest rate policy. With speculation about the Bank of Japan eventually ending this policy intensifying, foreign exchange traders have been impacted.

Sell signals are flashing on the technical front, and the yen exchange rate may experience significant volatility.

Herald van der Linde, Head of Asian Equity Strategy at HSBC in Hong Kong, said, "I personally remain cautious about this market." "Everyone is prepared for it, almost everyone has bought in," he said, adding that many positive news has already been fully priced in. HSBC has a "sell" rating on the Japanese stock market.

Some technical indicators seem to support this bearish view. The TOPIX is approaching its historical high set in 1989, but its relative strength index (RSI) recently reached its highest level since May 2023, indicating overbought conditions caused by overheated sentiment. Signs and implications suggest that a wave of sell-offs could come at any time. The last time this technical indicator broke the "overbought" threshold was in September last year, when the Japanese market fell by about 9%. Some market observers believe that trading in the Japanese stock market could become crowded.

In terms of index expectations, HSBC predicts that the TOPIX index will end the year at 2,460 points, a 1.3% decline from the current level. Societe Generale, on the other hand, expects the Nikkei 225 index, the benchmark for blue-chip stocks, to fall to 32,500 points by the end of June, an 8% decline from the current level.

Michael Dyer, Head of Multi-Asset Strategy at M&G Investments Hong Kong, said, "The short-term prices of many important stock targets have already been fully digested." "We have relaxed a bit. We have made some profits, and taking profits seems to be increasingly becoming a consensus trade."

His views are echoed by Kelvin Leung, Portfolio Manager at Robeco Hong Kong Ltd. Leung said, "In my opinion, the recent rally is still driven by momentum indicators and is quite overheated." "If you look at the breadth of the market, it is driven by large-cap stocks, technology, and automobiles. I would say it is still quite narrow."

If the Bank of Japan chooses to raise interest rates, the Japanese benchmark interest rate is likely to break in the opposite direction to the actions of the Federal Reserve. Expectations of a rate cut by the Federal Reserve will weaken the continued strength of the US dollar against the yen. Frank Benzimra, Head of Asian Equity Strategy at Societe Generale, said that this was one of the main reasons why the bank decided to reduce its allocation to Japanese stocks from 15% to 8% in November last year, as expectations of excessive volatility in the USD/JPY exchange rate "may slightly reduce the attractiveness of risk-return." Benzimra said, "We must recognize some foreign exchange risks, as the Federal Reserve is expected to ease monetary policy, while the Bank of Japan is expected to tighten monetary policy."

JPMorgan Private Bank is also closely monitoring the yen's appreciation trend, which poses a significant risk to their Japanese investment strategy. "One favorable factor we have seen in the Japanese stock market is the depreciation trend of the yen. Of course, this is not the only reason, but it is a key driving factor," said Alexander Wolf, Head of Asian Investment Strategy at JPMorgan. "Considering that it is already relatively cheap compared to the US dollar, we do expect the yen to appreciate, although not significantly in the short term." The market's long-term bullish sentiment remains strong.

Nevertheless, the majority of investment institutions still have a positive outlook on the further rise of the Japanese stock market, until it breaks through its historical high. Toshio Morita, the Chairman of the Japan Securities Dealers Association, recently stated that the Nikkei 225 Index could rise to 42,000 to 43,000 points this year. According to Japanese media reports, large financial institutions in the country have been increasing their staff size, focusing on market traders with experience in rising interest rate environments.

Hikaru Yasuda, Chief Equity Strategist at SMBC Nikko Securities, wrote in a report that with the Nikkei 225 Index reaching a new high in the middle of the year, the index could surpass 40,000 points. Yasuda wrote that although the recent upward trend of the index is similar to the rebound in April-June 2023, the momentum is stronger, indicating that overseas pension funds and sovereign wealth funds are engaged in a "long-term game".

Investors who are bullish on the Japanese stock market have pointed out that the exchange's policies aimed at increasing corporate valuations, such as the Tokyo Stock Exchange's capital improvement orders for companies with stock prices below book value, have helped boost enthusiasm for investments. This has benefited established undervalued blue-chip companies like the Daiwa Securities Group, whose stock price this week exceeded book value for the first time in six years.

Due to the weakening of the yen, which supports the scale of foreign capital inflows, and the strong stock price performance of many Japanese exporters, coupled with Japanese companies taking action to enhance shareholder value, blue-chip stocks with the nickname "Nippon Special Valuation" have attracted global investor funds. In 2023, the Japanese stock market outperformed most global stock markets and the benchmark stock index reached its highest level in over 30 years.

The Nikkei 225 Index and the TOPIX Index both had annual gains of over 25% in 2023, marking their best performance in a decade. Looking at the global picture, the Japanese stock market can be said to have outperformed global stock markets. The Nikkei 225 Index and the TOPIX Index ranked among the top ten in terms of global stock index gains in 2023, mainly due to the Tokyo Stock Exchange's continuous efforts to promote Japanese companies, especially undervalued blue-chip companies, to enhance shareholder value. This is accompanied by decades of deflation receding and being replaced by a moderate upward price trend.

The strong performance of the Japanese stock market is inseparable from the strong push of the "Nippon Special Valuation" concept. For many years, the Tokyo Stock Exchange has been helping Japanese companies with stock prices below book value and severely undervalued assets to formulate capital improvement plans. It has also been advocating and promoting significant increases in dividends and stock buybacks by Japanese blue-chip companies, further strengthening corporate governance capabilities, actively participating in new technology exploration and research, and global competition. This is the origin of the "Nippon Special Valuation" concept. At the same time, in the latest survey conducted by Bank of America on Wall Street in January, more than a quarter of investors expect double-digit returns in the next 12 months, higher than the one-sixth reported in the survey in December last year.

Statistics released by the Tokyo Stock Exchange on Thursday showed that foreign investors bought a net 956 billion yen (approximately $6.5 billion) of Japanese stocks last week, marking the largest inflow of foreign capital since early June last year. International demand has helped the Japanese stock market continue its outstanding performance compared to other major stock markets in the new year, with the benchmark Nikkei 225 index of blue-chip stocks rising 6.6% last week, the largest weekly gain since March 2022, pushing the index's annual gain to over 28%.

Kiyoshi Ishigane, Chief Fund Manager at Mitsubishi UFJ Asset Management, said that although he has reduced his exposure to Japanese stocks, he remains optimistic about the future of the Japanese market. He stated, "I have reduced my holdings of Japanese stocks and taken profits to some extent." "I also expect the yield on 10-year benchmark government bonds to rise again, which may continue to weigh on the stock market in the short term. However, the fundamentals of the Japanese stock market have not changed significantly, so I am bullish on the Japanese market in the long term."