Following Goldman Sachs' upward revision of its target for the Topix index, Citigroup has also aligned itself with the optimistic outlook for Japanese equities. Citigroup suggests that while Japanese stocks may be approaching a short-term peak, significant upside potential persists through the year-end, with a high-end estimate for the Nikkei 225 index reaching 72,000 points. The consecutive endorsements from these two major Wall Street institutions provide fresh support for the recently strong Japanese market.
According to the report, Citigroup's Japan Equity Strategy team published research on June 2nd, with lead author Ryota Sakagami stating: "Japanese equities may be approaching a temporary peak in the short term, but the upside potential through year-end remains significant. There is no need to alter the fundamentally positive view on Japanese stocks." The report concurrently raised the TOPIX target to 4,500 points, based on a price-to-earnings ratio of 17.5x and an EPS forecast of ¥258.4 for the fiscal year ending March 2028. The high-end estimate for the Nikkei 225 is 72,000 points, implying a "breakthrough above 70,000 points before year-end."
The core logic for this assessment rests on three pillars: earnings, return on equity (ROE), and fund flows, none of which are signaling an end to the trend. Short-term pressure stems from conservative initial corporate guidance leading to earnings forecast revisions, not a collapse in fundamental profitability. Simultaneously, Japanese companies' ability to pass on costs continues to strengthen, providing room for future margin improvement, which is a key basis for maintaining a positive medium- to long-term stance.
Goldman Leads with Target Hike, Citigroup Follows Suit
Just prior to Citigroup's report, Goldman Sachs had already raised its 12-month target price for the Topix index from 4,200 to 4,400 points in its latest Japan Weekly Strategy report, implying an approximate 11% gain from current levels, placing it among the leaders in major global markets.
Goldman analysts Bruce Kirk and Julius Chan raised their EPS growth forecasts for FY26/27 from +7%/+11% to +11%/+11% respectively, and added a new forecast of +9% EPS growth for FY28. They also set 3-month and 6-month target prices at 4,100 and 4,200 points.
Goldman cited three key drivers: stronger-than-expected corporate earnings seasons leading to significant upward EPS revisions, with cumulative three-year profit growth potentially reaching 33%; cumulative foreign net inflows of ¥16 trillion since April 2025; and record-high shareholder returns, with current valuations still having room to expand towards target multiples.
Citigroup's rationale aligns closely with Goldman's but delves deeper into specifics, particularly focusing on corporate pricing power, interest rate risk boundaries, and sector rotation paths.
Short-Term Pressure from Earnings Revisions, Not Collapse
The Nikkei 225 and TOPIX recently hit new year-to-date highs, with the market having partially priced in positive news. If subsequent corporate profit plans fall short of market expectations, earnings forecast revisions may weaken temporarily, putting pressure on stock prices.
However, this is not a scenario of "earnings collapse." TOPIX component companies plan revenue growth of 4.2% year-on-year, operating profit growth of 8.2%, and net profit growth of 7.6%. Compared to prior consensus, revenue is roughly flat, operating profit is 6.3% lower, and net profit is 4.9% lower. While the profit side is indeed conservative, it is not out of control.
The industry structure further supports this view. The electrical machinery and precision instruments sector plans net profit growth of 56.2% and operating profit growth of 21.4%. The manufacturing sector overall plans net profit growth of 19.5%. Companies linked to external demand plan net profit growth of 16.8%. High-tech and semiconductor-related sectors continue to lift the overall earnings base. Short-term adjustments are more about timing than direction.
Pricing Power is the Key Variable for Profit Improvement
The report notes that many companies have revenue plans exceeding market expectations, but an equal number have profit plans below expectations. Companies are willing to raise sales forecasts but remain cautious on margins, reflecting uncertainty about fully passing on costs.
Similar situations occurred in the fiscal years ending March 2023 and March 2024, where initial pressure was followed by price increases driving margin improvement. Currently, Japanese companies are passing through changes in import costs more smoothly than in the past. Brent oil price changes transmit to import prices with about a 2-month lag, import prices to corporate prices with another 2-month lag, and corporate prices to core CPI with about a 6-month lag, with B2B industries generally faster than B2C.
This means companies with "revenue guidance above expectations but profit guidance below expectations" warrant close attention. If subsequent price increases materialize and margins do not deteriorate as initially guided, these companies might see earnings upgrades. The base case forecasts TOPIX EPS rising from ¥209.4 for FY ending March 2026 to ¥230.6 for FY ending March 2027 and ¥258.4 for FY ending March 2028, representing growth rates of 10.1% and 12.1%, respectively. ROE is expected to gradually rise from 9.8% to 11.1%.
Valuations Not Cheap, but Rising ROE Supports Higher P/E
The current 12-month forward P/E for TOPIX is 16.8x, near the upper end of its range over the past decade, making it difficult to call cheap based on valuation alone. However, the core logic for valuation expansion lies not in continued fund inflows but in whether ROE can continue to rise.
The current 12-month forward ROE for TOPIX is 10.2%, with a P/B of 1.74x. If the average ROE moves towards the 11-12% range, a P/E above 17x would no longer appear excessive. Global financial conditions remain relatively accommodative. The number of Japanese companies with ROE below their cost of capital continues to decline, further enhancing the market's appeal to foreign capital. From a yield spread perspective, Japanese equities remain competitive against other major markets.
Based on this framework, the TOPIX target is set at 4,500 points, calculated as a 17.5x P/E multiple applied to the ¥258.4 EPS forecast for the fiscal year ending March 2028.
Nikkei's Outperformance Over TOPIX Unlikely to Reverse Soon
The Nikkei 225/TOPIX ratio (N/T ratio) is currently at a historically high level, primarily because AI and semiconductor-related stocks have seen larger gains, and the Nikkei 225 is more sensitive to such heavyweight sectors.
The report evaluates tech sector valuations using the PEG ratio: MSCI Japan IT's current 12-month forward P/E is 24.7x with a PEG of 1.3; Japan's semiconductor sector's 12-month forward P/E is 22.2x with a PEG of 0.8. Compared to looking at P/E alone, earnings growth has absorbed a significant portion of the high valuation, suggesting tech stocks are not in a clearly overheated state.
Therefore, the report maintains a high N/T ratio as the base case path. If the N/T ratio reaches 16x, it corresponds to a Nikkei 225 high of approximately 72,000 points, which is the quantitative basis for the "breakthrough above 70,000 points by year-end" call.
Interest Rate Rise Risks Manageable, but "Bad Rate" Scenario Warrants Caution
In mid-to-late May, Japanese long-term interest rates rose noticeably, leading to selling in high-valuation tech stocks and a short-term market correction, which stabilized quickly without turning into a sustained decline.
In the Japanese market, long-term interest rates and TOPIX P/E have often shown a positive correlation, differing from the logic in the US market. Reasons include: a higher weight of value stocks in Japan; Japanese long-term rates being more influenced by inflation expectations; and the Bank of Japan's long-standing accommodative stance, making it easier for real rates, even if rising, to stay below potential growth rates.
The scenario that truly requires vigilance is "bad rate rise" – if concerns over fiscal deterioration intensify, driving long-term rates higher due to real rates approaching or exceeding the potential growth rate, valuation pressure would increase significantly. A more extreme case would be the 10-year Japanese Government Bond yield breaking above 3% due to rising real rates. Currently, Japan's 10-year real rate has gradually risen to about 25 basis points, but this risk has not yet become a market theme.
Trading Themes: Tech Leads, Lagging Sectors Poised for Catch-Up
In an environment where oil prices have not fallen rapidly and inflationary pressures persist, the Japanese market resembles a mild stagflation scenario. Market preference favors stocks less dependent on the macroeconomic cycle, including thematic stocks, restructuring plays, and inflation beneficiaries.
Current buying is concentrated in tech stocks. However, if Middle East uncertainties subside, funds could flow into previously lagging momentum sectors, including construction, real estate, financials, defense, and energy. Automobile stocks are also mentioned separately – having underperformed due to bottleneck concerns, they still possess short-term rebound potential.
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