Japanese large caps to lead Nikkei 225 rally for now- Bernstein

Investing.com-- Japanese stocks with large market capitalizations are still expected to lead a stellar rally in the near-term, Bernstein analysts said in a note, but factors for a rally in small-cap stocks still remained in play.

Japan’s benchmark Nikkei 225 marked a stellar, nearly 30% spike in 2023 and was trading up about 20% so far in 2024, while also sitting at record peaks. 

Bernstein analysts noted that this rally was driven chiefly by consistent flows into the country’s biggest companies, on the back of attractive valuations, relatively low positioning and strong earnings growth and outlook in the sector. 

In the near-term, this trend is expected to continue, with Japan’s large-caps still seeing more space for foreign capital inflows and a sustained tailwind from earnings. 

Which Japanese big-caps should you look out for?

Bernstein analysts said they preferred a barbell of value and quality in their preferred Japanese large-cap stocks, as well as stocks with growth at a reasonable price.

Large-cap stocks touted by the brokerage include communications and consumer discretionary heavyweights Nintendo Co Ltd (TYO:7974) and Bandai Namco Holdings Inc (TYO:7832).

The brokerage also touted Japan’s biggest automobile producers as its picks, including Toyota Motor (NYSE:TM) Corp (TYO:7203), Honda Motor Co Ltd (TYO:7267), Nissan Motor Co., Ltd. (TYO:7201) and Isuzu Motors, Ltd. (TYO:7202).

In technology, Bernstein analysts picked Tokyo Electron Ltd. (TYO:8035), Disco Corp (TYO:6146), Lasertec Corp (TYO:6920) and Obic Co Ltd (TYO:4684). 

A bulk of the mentioned stocks are major exporters, and also stand to see earnings support from a weak yen. The Japanese currency recently sank to its weakest level since 1990, amid dovish cues on the Bank of Japan and pressure from the prospect of higher-for-longer U.S. interest rates. 

What would it take for a Japanese small-cap rally?

Bernstein analysts noted that while valuations for Japanese small-cap stocks remained attractive, they still saw the space as “already quite crowded.” 

With the Japanese stock market’s bull run now extending into a second year, investors were expecting a more broad-based rally in equities, which could see small and mid-cap stocks outperforming. But Bernstein analysts also noted that the last two multi-year bull cycles- seen in 2003-2005 and 2012-2017- presented differing cues on such a trend. 

Still, Japanese small-caps have shown a history of outperformance. 

Bernstein analysts expect the space to pick up in the event of a strong, global risk-on rally on the back of a broader economic recovery- which “typically results in a risk-on rally favoring small-caps.” 

“We would keep a close eye on any reversal in earnings or macro support for small-caps.” 

Analysts also expect small caps to pick up as the risk-on rally gains pace and domestic investors begin buying en-mass into the sector.