Japan's stock market hit a two-and-a-half month low on Thursday as investors took their cues from a stronger yen, but analysts told CNBC the pullback should only be temporary.
"The Nikkei was up 55 percent last year in yen terms… it had a very impressive year, so it's not surprising that we're seeing shorter-term profit taking but… opportunities are still quite good there," said Stephen Davies, CEO, Javelin Wealth Management, told CNBC Asia's Squawk Box on Thursday.
The Nikkei was down 3.3 percent by midday on Thursday in Asia, trading at 14,872.
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Last year was a stellar year for Japan's financial markets, as Prime Minister Shinzo Abe put his ambitious plan for economic reform into practice, helping to revitalize investors' appetite for Japanese stocks the world over, while a rapid weakening of the yen substantially boosted profits for the nation's export-led economy.
However, doubts have arisen over whether the momentum will continue in 2014, and Japan stocks are down 8.6 percent this year so far. It's largely believed that a consumption tax hike scheduled for April will give Japan's economic recovery a knock, while Abe's commitment to the third arrow of his economic plan – structural reform – is also a common gripe. Abe has spoken at length of plans for corporate tax cuts and labor market reforms, but the market is yet to see any solid action.
Davies told CNBC that progress on this final arrow would prove vital to the success of 'Abenomics.'
"There is always a bit more room in the Japanese market to take advantage of the impact of a weaker yen, and that's all very positive, but in order for it to march higher and maintain those levels you need to see much more constructive action on the part of government," he added.
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A pedestrain looks at a share prices board in TokyoKazuhiro Nogi | AFP | Getty Images
Mark Davids, fund manager of JP Morgan's Japan Strategic Value Fund, told CNBC he thought Japanese equities had a lot further to run.
He pointed out that valuations were still not stretched, at 14 times earnings and 1.3 times price to book, while companies' return on equity has risen from to 9 percent and corporates earnings revisions are skewed to the upside.
"Arguably Japan should be trading at a higher multiple than it currently is… If you compare that [corporate earnings revisions] to other markets around the developed world, this strength in corporate earnings still stands out considerably," he added.
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A potential wild card for Japanese stock market, however, will be the outlook for its domestic currency. The yen weakened 21 percent against the dollar last year, but the recent re-emergence of emerging market turmoil has prompted some safe haven buying, strengthening the yen back to around 102 against the greenback.
Further yen strength would be bad news for stocks, especially corporates who rely on the profit boost a weaker yen gives them when the repatriate their overseas earnings back home, and Japan's stock market and currency are historically strongly correlated.
But Javelin Asset Management's Davies said this risk factor had been overegged.
"The yen fell to 102 [per dollar] by the end of last year… and that was taking place at a time when emerging markets were under pressure. That [yen weakness] is a function of central bank stimulus and the deliberate weakening of the yen that took place at the time," he said, suggesting emerging market weakness would not have a major impact on the yen.
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