Japanese stocks face continued risk aversion despite record profits, Nomura says

Japanese stocks could continue to face risk-averse sentiment, despite companies posting record profits, according to Nomura. In fiscal 2026's first quarter, Japanese firms reported a profit growth of around 50%, significantly above the 25% consensus forecast. Return on equity hit a record 12.1%, and operating margins reached an all-time high of 9%.

However, Nomura warns that roughly half of this profit surge originated from one-off factors, such as foreign-exchange gains, tariff refunds, and inventory valuations. The remaining half was driven by fundamental factors like increased volumes and price hikes. This distinction explains why strong earnings haven't led to commensurate share-price gains, as some temporary boosts may reverse, and position adjustments have negatively impacted stocks after results.

The discrepancy is evident in the major indexes: the TOPIX has consistently set new highs, while the Nikkei 225 has struggled to return to its late-June peak. Nomura attributes part of this divergence to investor caution following the AI and semiconductor-related share surge earlier in the year. Valuations also warrant caution, as both the TOPIX and Nikkei 225 trade above their historical price-to-earnings ranges, at 16-17 times and 22-23 times earnings, respectively.

Despite these concerns, Nomura maintains a bullish outlook, projecting the TOPIX to reach 4,400 by the end of 2026, 4,600 by 2027, and 4,800 by 2028. The Nikkei 225 is expected to follow a similar trajectory, reaching 70,000, 73,000, and 76,000 by the same periods. This bullish case hinges on sustained earnings growth, which Nomura anticipates.

They have raised their TOPIX EPS forecasts to 244 for fiscal 2026, 269.1 for 2027, and 287.2 for 2028, indicating growth of 19.2%, 10.3%, and 6.7%, respectively. Additionally, Nomura sees strong shareholder returns supporting demand, forecasting total dividends of ¥31.6 trillion and share buybacks of ¥24 trillion for fiscal 2026, resulting in total shareholder returns of ¥55.6 trillion, up 23.3% year-over-year.

However, Nomura doesn't currently anticipate the Bank of Japan tightening enough to significantly harm earnings or the economy. They assume a terminal BOJ rate of 1.75% and maintain that financial conditions remain accommodative in Japan. The main risk, according to Nomura, is a "bad" rise in interest rates, as Japan's nominal GDP growth remains above 10-year Japanese government bond yields, preserving the favorable gap between economic growth and long-term rates that supports equities. Nonetheless, a sharp increase in yields could jeopardize the market's valuation support.