By Ayai Tomisawa
TOKYO (Reuters) - The Nikkei share average ended at a 21-month high on Thursday, led by exporters and financials, as the new Japanese prime minister's vow to battle deflation and a strong currency buoyed investor risk appetite.
The Nikkei advanced 0.9 percent to 10,322.98, rising for the third consecutive session and taking the index deeper into "overbought" territory, with its 14-day relative strength index at 77.7, far above 70 which is considered overbought and often indicates an imminent pullback.
The benchmark has advanced 19.2 percent over the past six weeks, taking the year-to-date increase for the Nikkei to 22.1 percent, outpacing a 12.9 percent rise in the U.S. S&P 500 and a 14.7 percent gain in the pan-European STOXX Europe 600.
It is on track to log its best yearly gain since 2005.
"People are back in the office today...and putting on some positions based on what we saw after the cabinet appointment and LDP policy decision," a dealer at a foreign brokerage said, referring to the ruling party.
Finance Minister Taro Aso said Prime Minister Shinzo Abe has ordered him to compile a stimulus package without sticking to the previous government's cap on new bond issues, signalling a more aggressive policy to kick-start the ailing economy.
Financials such as insurance stocks rose. Dai-ichi Life Insurance Co <8750.T> added 2.0 percent and T&D Holdings Inc <8795.T> gained 3.9 percent.
Exporters benefiting from a weaker yen included Toyota Motor Corp <7203.T>, Honda Motor Co <7267.T>, TDK Corp <6762.T> and Panasonic Corp <6752.T>, all up between 1.0 and 2.6 percent.
The yen hit a more than two-year low of 85.835 yen to the dollar. A weaker yen helps lift exporters' overseas earnings when repatriated, improving their competitiveness, particularly against South Korean and Chinese rivals.
Helped by the drop in the yen, the pace of deterioration in Japanese companies' earnings outlook has slowed further in December.
Their one-month earnings momentum - analysts' earnings upgrades minus downgrades as a total of estimates - stood at -7.2 percent, versus -10.9 percent in November and -12.2 percent in December.
On top of Thursday's gains in stocks that benefited from the new government's policy, shares in other sectors such as paper companies and personal finance companies also attracted buying.
But traders said such buying could fizzle anytime soon as investors seem to have overlooked fundamentals.
"Even junk stocks like consumer finances are rising... individual traders who are trading short-term could be buying them while forgetting that their earnings are far from rosy," said Makoto Kikuchi, the chief executive of Myojo Asset Management.
"They may be hoping that the LDP-led government will be relaxing regulations on the sector, but I don't think it's rational buying, and it could trigger profit-taking in any moment," Kikuchi said.
Aiful Corp <8515.T> gained 2.9 percent, while Orient Corp <8585.T> added 5.3 percent.
The paper sector was the best sectoral performer, gaining 3.5 percent. Nippon Paper Group climbed 3.8 percent, Rengo Co <3941.T> advanced 3.4 percent and Oji Holdings <3861.T> jumped 5.0 percent.
The broader Topix gained 0.8 percent to 854.09 in active trade, with 3.47 billion shares changing hands, close to last week's average daily volume of 3.53 billion shares.
(Reporting by Ayai Tomisawa; Editing by Matt Driskill and Ryan Woo)