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

Nomura flags that Japanese stocks may stay vulnerable despite recurring profit growth of ~50% in fiscal 2026 Q1, because ~half of the outperformance is one-off (FX gains, tariff refunds, inventory valuations). Valuations also look stretched (TOPIX ~16–17x earnings vs Nikkei 22–23x, above historical ranges), even as Nomura raised TOPIX EPS to 244 (FY26), 269.1 (FY27) and 287.2 (FY28) and forecasts FY26 shareholder returns of ¥55.6T (+23.3% YoY) from dividends of ¥31.6T plus buybacks of ¥24T. The key downside risk is a “bad” rise in Japanese yields: the BoJ is not expected to tighten enough to break the earnings/economy outlook, but a sharp increase in rates could erode valuation support.

Analysis

The market is separating durable capital-allocation improvements from cyclical noise, and that matters more than the latest EPS print. If buybacks/dividends stay elevated, the winners are the higher free-float, shareholder-friendly names; the losers are the crowded duration proxies that have already re-rated on the assumption of perpetually easy policy. That argues for breadth over headline beta: TOPIX exposure should remain better supported than the more expensive, narrower Nikkei complex.

The key catalyst is not earnings season, but the next move in JGB yields and BOJ signaling. A slow grind higher in rates is constructive for financials, but a sharp move is the classic multiple-compression event: equity valuations can de-rate before net interest margins have time to improve. The first 1-3 months are about positioning and flow; the 6-18 month question is whether corporate governance can keep replacing fading FX/tariff tailwinds with genuine operating leverage.

The consensus may be underpricing how much of Japan's equity story is now a rates-and-duration trade in disguise. If domestic yields rise without a matching acceleration in nominal growth, the market's valuation support weakens quickly; if yields stay contained, then the buyback bid can keep grinding prices higher even on modest earnings growth. The risk/reward is therefore better in relative trades than in outright chasing of the most expensive benchmarks.

Key Decisions for Investors

• Long DXJ / short EWJ for 3-6 months: cleaner expression of a yen-strengthening / BOJ-hawkish surprise without taking full unhedged currency risk. Favors a 'bad rates up' scenario; cut if USD/JPY resumes trending weaker or JGB yields roll over.
• Add on pullbacks to broad Japan exposure via TOPIX-linked vehicles rather than Nikkei-heavy beta. The valuation gap leaves more room for TOPIX to outperform if buyback breadth stays strong and AI/semis stop carrying the whole index.
• Use EWJ put spreads into the next BOJ meeting as a hedge against a rapid yield shock. This is a lower-premium way to position for the tail risk that rates rise faster than earnings can re-rate.
• Watch Japanese financials as a relative winner only if the 10-year JGB rise is gradual; if the move is abrupt, prefer short-duration defensives and REITs over banks. The falsifier is a stable curve with no follow-through in yields.