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Investors feeling dizzy after rapid ascent

TOKYO -- On Friday, the Nikkei Stock Average index rose past 20,000 points for the first time since April 2000. Now that the long-coveted goal has been met, and a lot sooner than many had anticipated, some investors appear to be feeling nervous about what may lie ahead.

The Nikkei Stock Average hit a 15-year high on Friday morning in Tokyo.

     After some deep valleys and low peaks, the stock index has finally come back to the level it was at 15 years ago. But further advances from here on are not a given. How much higher the Nikkei will go will depend largely on how far Japan can transform its economy and the way businesses operate.

     Foreign investors have been a major driver for the bullish run in the Japanese stock market over the recent months, but they "do not necessarily have complete faith in the future of the Japanese economy," Akio Yoshino, chief economist at Amundi Japan, warns.

     The Nikkei Stock Average stayed above the 20,000 level only for a brief period during Friday morning trading. It gradually declined after hitting the high point, as investors felt the market had achieved a short-term milestone. The index ended the day at 19,907 points, 30 yen lower than the previous day's close.

     It is not hard to see that investors are nervous about where the market will go next -- the Nikkei could keep rising for some time, but it is also possible it may have run as high as it can for now. 

Fear of heights

Four concerns appear to be occupying investors' minds as they figure out what to do next.

     The first concern is that the stocks may have risen too fast. This is understandable given that the Nikkei has climbed more than twofold since November 13, 2012. On that day, just before the Japanese stock market started taking off on expectations of an election victory by Shinzo Abe and his Liberal Democratic Party, the Nikkei Stock Average closed at 8,661 points.

     Many experts dismiss worries about the rapid pace of stock price gains. "At the most, the market may be slightly overheated," said Masayuki Kubota, chief strategist at Rakuten Securities' Economic Research Institute. "It is nothing to be concerned about when compared to bullish runs in the past.''

     Data backs up such a view. The divergence between the Nikkei Stock Average and its 26-week moving average had widened to nearly 30% right before May 2013, when a comment hinting the end of the U.S. Federal Reserve's quantitative easing by then Chairman Ben Bernanke caused turmoil in the global financial market. Lately, the divergence has remained at a little more than 11%.

     The second concern is that Japanese stocks' price-earnings ratios may now be too high after months of gains. This, again, is dismissed by data. Projected PERs for fiscal 2015, which ends March 2016, indicate Japanese stocks are not particularly expensive compared to stocks in other major industrialized countries.

     Even based on a bullish assumption that listed Japanese companies' profits will increase by 15% in fiscal 2015, their overall PER comes to 16.4, while the average PER in the three preceding years stood at 16.1. U.S. stocks' projected overall PER is at 19.1, with the three-year average showing 16.4. With U.K. stocks, figures are 14.2 and 11.8 respectively. German stocks' forward PER is 17.5, with their average three-year trailing PER sitting at 13.1.

     These figures show the price of Japanese stocks is rather reasonable. They also show Japanese stocks' forward PER is more aligned with the three year average PER.

     The third concern is that stock prices have gone up only because pension funds have been forced to move into stocks due to the Bank of Japan's aggressive monetary easing policy. This view is not entirely accurate, according to Kubota.

     "If stocks had gone up despite all other investing entities unloading their shareholdings, then yes, you can say price gains occurred, thanks to pension funds," the chief strategist at Rakuten Securities' Economic Research Institute said. "But as evidenced by foreign investors buying Japanese stocks after comparing them with other countries' shares, the recent rise in the Japanese stock market has not been driven by pension funds' buying alone," Kubota added.

     The fourth concern is whether corporate governance reform at Japanese companies would really help Japanese stocks perform better. This concern can be easily addressed when considering that such reform will likely lead to more discussions over business plans between companies and institutional investors. More information disclosure by companies would enable investors to avoid unknown risks or take more calculated risks.

Bullish, yet cautions 

Meanwhile, the unexpectedly weak March U.S. job figures, released on April 3, increased the chance of excess liquidity from monetary easing continuing to fuel stock gains. As there are growing expectations that interest hikes in the U.S. will not happen until September at the earliest, investors will likely continue piling into stock markets.

     Amid the situation, some market experts predict the Nikkei Average will blast past the 20,000 level. 

     "The next target will be 22,666 points, which was reached in June 1996," said Hideshi Aratake at Kokusai Asset Management.

     Others are more cautious. Japanese stocks have been bought because they are among the least bad investment options, according to Yoshino. "Investors are finding it difficult to put money into bonds because of ultra low interest rates and even negative yields. U.S. and European stocks are also not attractive because of their high PERs," he said. 

     This means Japanese stocks could easily lose their attraction. The Japanese economy has been blessed with a weaker yen and falling oil prices in recent months, but it is crucial for the Japanese government and businesses not to become complacent. If they ease back on the efforts to reform the economic structure and improve capital efficiency, foreign investors may be convinced that promised changes are not forthcoming and quickly pull their funds out of the Japanese stock market. 

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