The rebound in stocks, fueled by Prime Minister Shinzo Abe's pledge to stimulate the economy, probably helped banks make up some of the losses they incurred on their equity holdings in the fiscal first half, said analysts at UBS AG and BNP Paribas SA. Signs are emerging that domestic lending is recovering, with loans at city banks climbing for the first time in three years in December.

“Megabanks look attractive to investors given the recent rally in the stock market,” said Shinichi Ina, a Tokyo-based analyst at UBS. “That's cutting impairment losses tied to banks' shareholdings as well as pushing up their sales of mutual funds and spurring income at their brokerage units.”

Eoin Treacy's view We have long said at Fullermoney that action to devalue the Yen would act as a catalyst for investor interest in Japan's large export led sector. Considering the clear intention of the Prime Minister Abe to weaken the Yen, the availability of Yen to speculators and near zero interest rates the conditions for a carry trade are becoming increasingly compelling.

The leadership of the banking sector over the last 18 months can be seen as a tailwind for the market and an indication that liquidity provision is a dominant factor in the performance of equities. The Topix Banks Index / Topix Index ratio has held a progression of higher reaction lows since June 2011 and a break in this sequence would be required to question medium-term scope for continued outperformance.

In absolute terms, the Topix Banks Index rallied from late November to break the multi-year progression of lower rally highs. It broke out of its most recent short-term range today and a sustained move below 130 would be required to begin to question medium-term scope for continued upside.

The three largest institutions represent 63.7% of the sector's weighting. Mitsubishi UFJ Financial Group spent most of January consolidating its earlier powerful advance and broke out to new recovery highs today. A sustained move below ¥450 would be required to begin to question medium-term scope for additional upside. Sumitomo Mitsui Financial Group and Mizuho Financial Group share similar patterns.

The outperformance of the small cap Topix 2nd Section Index is also noteworthy. This index has often been a lead indicator for the wider market probably because smaller cap shares are sensitive to changes in the liquidity environment. If one studies the Index's historic performance it often posts a run of consecutive weeks to the upside followed by a run of consecutive weeks to the downside. The present rally which completed the more than 4-year base has been in place for 12 consecutive weeks. While it is becoming increasingly overbought in the short term, a clear downward dynamic would be required to check momentum.