(Bloomberg) -- The stock rally that pushed Japan’s Nikkei 225 Stock Average past a record that stood for more than three decades looks set for further advances as foreigners rush back in.

That’s the view of investors and strategists, who are also watching for a potential broadening of equities gains that may take the wider Topix index to an all-time high this year. Fund flow data indicate there’s scope for trillions of yen to return to Japan’s stock market based on figures compiled by Bloomberg.

With the nation’s deflation era now seemingly behind it, Japanese companies showing signs of sustained profit growth and the Tokyo Stock Exchange championing shareholder interests, some analysts project gains of more than 10% for the Nikkei. The Topix also remains about 8% below its 1989 peak.

Read more: How the Nikkei Found Its Mojo in World-Beating Stocks Rally 

“We think there are solid fundamental drivers of this rally, and that it can continue for some time, supported by corporate governance reform and improved cash returns to shareholders,” said James Halse, portfolio manager at Platinum Asset Management Ltd. “It seems likely that more global investors will be feeling the pressure to allocate to Japan given the strength of the market’s performance in recent times.”

Historical data suggest more funds may pour in from abroad. In 2013, when former Prime Minster Shinzo Abe’s economic measures known as “Abenomics” got started, Japanese stocks attracted ¥15 trillion ($99.5 billion) in foreign inflows, according to weekly data from the nation’s stock exchanges compiled by Bloomberg. 

But overseas investors soon reversed course: their funds flowed out of Japanese equities in six out of eight years through 2022, during which they sold ¥15 trillion of shares on a net basis. Less than ¥6 trillion has come into Japan’s equity market so far since the beginning of 2023, indicating further room for money to return.

“Investors are still under-allocated to Japan despite it being cheaper than developed peers,” Eastspring Investments’ head of Japan equities Ivailo Dikov and portfolio manager Oliver Lee wrote in a note earlier this month.

Large companies in particular will benefit as investors rush in due to fear of missing out, said Takehiko Masuzawa, head of equities trading at Phillip Securities Japan Ltd. 

Overseas funds, who have been the dominant force in the rally, will keep buying well-known companies that are covered by equities analysts, said Sohei Takeuchi, a senior fund manager at Sumitomo Mitsui DS Asset Management Co. “The key to a long-lasting market is whether money will be able to circulate to the mid- and small-cap segments.”

The Nikkei 225’s rise on Thursday to 39,098.68 came as chipmaker Nvidia Corp.’s robust earnings provided a boost to tech shares, which have enjoyed a resurgence in Japan.

The gauge has soared almost 45% over the past year, led by stocks including Tokyo Electron Ltd. and Nvidia supplier Advantest Corp.

Concern over China’s economic slowdown and Beijing’s heavy hand over the market have also prompted global investors to shift allocations to Japan.

Still, there are risks that could derail the upward path for Japanese equities, at least in the short term.

The Nikkei’s 14-day relative strength index is showing technical signs of overheating. Funds could also shift back to China as quickly as they came in, if signs of stability and growth return in Asia’s biggest economy. 

There are concerns the yen’s weakness may have gone too far and that it’s set to strengthen, especially with the Bank of Japan expected to end its negative interest rate regime. A rebound in the currency would likely weigh on exporters.

“I wouldn’t buy now,” said Kiyoshi Ishigane, chief fund manager at Mitsubishi UFJ Asset Management, who is overweight Japanese stocks and has been gradually taking profit amid expectations that shares may correct in the short term if the BOJ tightens and the yen strengthens. But Ishigane still sees corporate profitability as improving and shares to be supported by fundamentals. “We’ll buy on dips,” he said.

Japanese companies logged record profits last quarter, supported by the resilient US economy and the weak yen. More firms have been able to improve their margins as inflation let them pass on rising costs to consumers. Wages are also rising, which gives shoppers more purchasing power.

With the market positioned for an imminent BOJ policy move, robust earnings and structural changes, there “doesn’t appear to be any reason why the rally can’t extend,” said Tony Sycamore, a market analyst at IG Australia Pty. “It’s not too hard to see a blow-off type move taking the Nikkei towards 42,000 or 43,000 in the coming months.”

--With assistance from Abhishek Vishnoi.

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