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Japan’s equity rally last year in the face of foreign selling is challenging conventional wisdom that purchases by overseas investors are necessary for the market to keep rising. And that breakdown in correlation bodes well for the country’s shares.

The key 225-issue Nikkei average advanced 16% in 2020 despite more than ¥6 trillion of foreign net selling in the cash and futures market, according to Japan Exchange Group data. It was the first time since 1989 that the blue-chip gauge recorded a double-digit gain amid net foreign selling.

The phenomenon suggests the nation’s local investors have been playing a larger role in setting the market’s trend. The Bank of Japan was the largest domestic entity to purchase local equities last year, doling out ¥7.1 trillion in net buying. Japanese institutions including insurers and banks were also net buyers of ¥7.6 trillion worth of shares during the period, according to data compiled by Mizuho Securities Co.

"It does seem clear that foreigners are not needed for a bull market anymore,” said John Vail, the chief global strategist at Nikko Asset Management Co. in Tokyo. "That seems like an antiquated rule of thumb that no longer applies.”

While foreign traders have been net buyers so far this year, they were annual net sellers of Japanese equities 13 times since 1982. The Nikkei slid 12% in 2018 as net selling by foreign traders reached ¥13.2 trillion. The gauge slumped 42% in 2008, when they offloaded ¥3.7 trillion of shares. The Nikkei rose 0.2% to 28,609.57 as of 11:01 a.m. in Tokyo on Wednesday.

Seiichi Suzuki, a market analyst at Tokai Tokyo Research Institute Co., estimates that for every ¥1 trillion in foreign buying last year, the Nikkei got a boost of 5.5%. The same amount of selling weighed on it by 1.8%, indicating the market is becoming more resilient to foreign outflows, he said.

Persistent BOJ buying of exchange-traded funds is helping to offset foreign sales, said Shusuke Yamada, a strategist at Bank of America. The central bank last year raised its annual purchase target to ¥12 trillion from ¥6 trillion at the height of the pandemic, although buying has slowed in recent months.

"It’s a big deal that there’s someone buying whenever the market dips,” he said. "The fact the BOJ is there to buy isn’t going to change this year.”

Nikko Asset’s Vail said other domestic players are also playing a significant role in the market as they search for higher returns amid a prolonged period of low yields. Those investors will set the stage for a "long-term bull market” regardless of which way foreigners decide to bet, he said.

"It does seem like Japanese domestic investors really do understand now that the stock market is not a gambling den — it’s a good way to invest your money,” Vail said. "It really shows that the equity culture here now has become solid.”

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