SINGAPORE - As Japan's stock market sits atop 33-year highs last seen during the country's 'bubble" era, investors are bullish that the rally in the world's third-largest market has only just begun.
Cheap valuations, corporate reforms, outflows from China, low rates and, not least, optimism from billionaire U.S. investor Warren Buffet are fuelling the buying from foreign funds.
Fund managers say interest in Japanese stocks is at its highest in nearly a decade and, despite the steady inflow over the past six months, foreign investors remain underweight, leaving room for allocations to shift.
A strong earnings season, a weaker yen and an economy that is showing signs of a sustained recovery have all helped the Nikkei surge to multi-decade highs.
The index crossed 31,000 on Monday - hitting a fresh 33-year peak. Yet, as gains top nearly 20% for the year, making it the best performing Asian stock exchange and just behind the tech-heavy Nasdaq in the global scorecard, investors are still chasing the rally.
"From where I sit it feels that Japan is suddenly attracting a lot of interest, as it hits its highest market level since The Bubble," Richard Kaye, Japan-based portfolio manager at asset manager Comgest, said.
He recently fielded calls with U.S. institutions looking to make their first investment in Japan, and was asked last month to authorise a $150 million capacity increase for a European client's Japan mandate.
Brokerage SMBC Nikko Securities expects the Nikkei to end the year at 35,000, while Sumitomo Mitsui DS Asset Management expects the index at 33,500.
Global investors are returning to Japan in 2023 after three straight years of pulling out, with foreign flows into Japanese equities and futures at $30 billion so far this year, according to UBS.
Foreign investors pumped 5 trillion yen ($37 billion) into Japanese stocks in April, according to JPMorgan, a monthly milestone the brokerage says has happened only six times in history.
The pull and push for investors began with Buffett's endorsement of Japan and Tokyo Stock Exchange's call for capital efficiency improvement.
That spurred a rally which has helped the Nikkei somewhat shrug off its 'value trap' moniker, because of how companies focus on market share, hoard cash and care little about shareholder returns.
Now investors see Japanese companies proactively improving return-on-equity. Share buybacks for the fiscal year ended March totalled 8.5 trillion yen ($62.9 billion), with companies announcing 3.5 trillion of those in the final quarter, according to Societe Generale.
"I see even from companies who traditionally cannot be looked at as taking a lot of these things seriously are becoming much more serious about it," said Ivailo Dikov, head of Japan equities at Eastspring Investments.
"I think in Japan ... it's very difficult to be seen as a laggard."
Japan had the largest foreign investor net equity inflows in April with $15 billion, followed by India with $1.92 billion, according to Morgan Stanley. In contrast, Taiwan had the largest outflows at $1.7 billion, followed by China, as geopolitical risks heighten.
Jon Withaar, head of Asia special situations at Pictet Asset Management, is more comfortable chasing value in Japan rather than China and has increased exposure to Japan recently.
"The market in Hong Kong, in particular, is trading with a sense of inevitability of further geopolitical escalation."
Hong Kong's Hang Seng index is roughly flat this year as the exuberance over China's economic reopening after three years of strict pandemic measures fades.
UBS global strategists recommend being long Japan rather than U.S. equities for the remainder of the year.
The market remains cheap too, trading at a price-to-earnings ratio of 17.6 compared with 27.6 for Nasdaq and 22 for S&P 500 index, according to Refinitiv data.
Some large investors have so far sat out the rally, wary of the Nikkei's historical propensity to disappoint and the uncertainty over when the Bank of Japan unwinds its massive monetary stimulus that will weigh on stocks.
The market is also looking overheated, with technical indicators showing both the Nikkei and broader Topix index in overbought terrain and leaving them vulnerable to profit taking.
T&D Asset Management expects the Nikkei to end the year at 27,500, a drop of nearly 14% from current levels. ($1 = 135.0500 yen)
(Reporting by Ankur Banerjee in Singapore, Summer Zhen in Hong Kong and Kevin Buckland in Tokyo; Editing by Vidya Ranganathan and Jacqueline Wong)