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Analysts said that the disruption to the Japanese market from the unusual bailout plan for Cyprus seems to have run its course, although the Japanese equities market is prone to volatility because it is vulnerable to a rise in the yen when global market uncertainty increases.
"It looks like the bailout issue will be contained in Cyprus itself and it probably won't spread to the euro zone. As the Japanese market was rallying lately, Monday's selling served as a good opportunity for correction," said Yutaka Miura, a senior technical analyst at Mizuho Securities. "But European debt issues will likely take years to be resolved, and we need to be prepared for a sell-off like this again as the Japanese market could easily get hit by a strong yen when investors buy the yen."
The Nikkei <.N225> added 247.60 points to 12,468.23 after sliding 2.7 % on Monday, its biggest one-day drop in 10 months. The index is just 0.74 % away from a 4-1/2 year high of 12,560.95 marked last Friday.
Ahead of a parliamentary vote in Cyprus that will either secure the island's financial rescue or threaten default, euro zone ministers have urged Cyprus to let smaller savers escape a controversial levy on bank deposits.
Still, investors are concerned that forcing ordinary citizens to fund bank rescues up front, through a tax on deposits, is setting a precedent that could lead to other bailout countries imposing something similar on depositors.
On Tuesday, Monday losers such as exporters and financials were bought back. Sony Corp <6758.T> surged 6.8 % and was the most-traded on the main board by turnover. Mazda Motor Corp <7261.T> jumped 5.6 % and Nikon Corp <7731.T> rose 3.4 %.
The broader Topix gained 1.7 % to 1,045.89 in relatively thin trade, with 2.84 billion shares changing hands. Last week, average daily volume was 3.72 billion shares.
The benchmark Nikkei has rallied nearly 44 % since mid-November when Prime Minister Shinzo Abe embarked on aggressive fiscal and monetary expansion campaign to revive the ailing economy.
Investors are also focused on the U.S. Federal Reserve's two-day policy-setting meeting starting on Wednesday and the change of leadership at the Bank of Japan this week.
"Investors are ready to chase the market higher to 13,000 on hopes for easing by the new leadership next month," said Mizuho's Miura.
Still upbeat
Goldman Sachs remained upbeat on Japanese equities, lifting its 12-month Topix <.TOPX> target to 1,250 from 1,100.
"Without a doubt, going 'long Japanese equities' has become one of the most popular trades among global investors in 2013. This is not to say, however, that every long-only foreign investor is neutral or overweight Japan," Goldman Sachs said in a note.
"We estimate that if the underweight gap of 2.8 % points of EAFE-benchmark mutual funds were to close, this could imply roughly $42 billion of potential foreign inflows from this investor segment." (EAFE=Europe, Australasia, Far East)
Foreign investors bought 1.12 trillion yen worth of Japanese shares in the week through March 9, their largest net purchase since the Ministry of Finance began collecting the data in 2005.
Market participants said that Japan's decision to join Trans-Pacific Partnership (TPP) membership talks was acting as a long-term catalyst to chase the market higher.
"This is, in our view, clear evidence that Abe is not just about 'buying growth' ahead of the July elections, but really about a fundamental pro-growth policy change," Jesper Koll, head of Japanese equity research at JPMorgan, wrote in a note, adding that banks would be a prime beneficiary if TPP forced a rise in competition, which would mean that companies would re-invest in buildings and facilities as well as accelerate mergers and acquisitions.
