The Nikkei average hit its highest close in 10 months on Monday, buoyed by stronger-than-expected U.S. jobs data and a report that Mitsubishi Chemical was in talks to acquire resin maker Mitsubishi Rayon.
Japan's machinery orders, a leading indicator of capital spending, rose in June for the first time in four months, helping shares such as Komatsu Ltd, though Japanese manufacturers forecast a sixth straight quarterly fall in orders in July-September.
Market participants said the latest upbeat data reinforced investor optimism about economic recoveries in Japan and the United States, which has helped the benchmark Nikkei recoup about 50 percent from a trough marked in March.
But they warned investors were turning cautious as the market's recovery run had been too rapid and they still need to see more evidence of the economic turnaround. The benchmark index lost steam in the afternoon, ending trade off the day's highs.
"The trend for the market now appears to be to keep going up little by little, as investors have strong hopes for the economic recovery," said Naoki Koga, senior fund manager at Toyota Asset Management.
"But the pace of gains has been rapid, and I feel more and more investors are leaning toward taking a wait-and-see position. If disappointing news were to emerge, such as poor economic data or downward revisions to earnings, the market could stumble."
In light trade, the benchmark Nikkei rose 1.1 percent or 112.17 points to 10,524.26, its highest finish since Oct. 3.
The broader Topix climbed 1.3 percent to 969.24.
Market analysts said the Nikkei's next target is likely to be 10,800, though the run-up will likely be interspersed with profit-taking.
The level is where the Nikkei last saw in October and a 50 percent Fibonacci retracement from its June 2008 high and last October's 26-year low just under 7,000.
The U.S. unemployment rate fell in July for the first time in 15 months as employers cut far fewer jobs than expected and that lifted Wall Street on Friday.
Media reports on the Mitsubishi merger talks also helped boost investor sentiment, said Tsuyoshi Segawa, equity strategist at Mizuho Securities.
"We have seen a series of merger stories in the short span of time, and that is welcoming development for the market," Segawa said.
Last month, Japanese brewer Suntory Holdings said it was considering options including a merger with larger rival Kirin Holdings Co, which would create one of the world's largest beverage and food firms.
MITSUBISHI RAYON STRONG
Mitsubishi Rayon powered 19.8 percent higher to 327 yen after the Nikkei business daily said Mitsubishi Chemical, Japan's top chemical firm, is in talks to acquire it in a deal worth up to 200 billion yen ($2.1 billion).
Mitsubishi Chemical gained 4.7 percent to 443 yen.
The Nikkei report also said the two companies are likely to agree on a deal as early as this autumn and plan to complete the transaction in spring next year. They do not currently have capital ties.
"The deal would give them a chance to focus on high-end, high-performance resins and distance themselves from fierce price competition in basic petrochemical products," said Nobuhito Owaki, analyst at J.P.Morgan Securities.
Exporters got an extra boost from a weaker yen, with the U.S. dollar staying above 97 yen, retaining broad gains made on Friday after the U.S. jobs data. A weaker yen helps boost exporters' profits when they are repatriated.
Honda Motor Corp advanced 3.6 percent to 3,210 yen, Canon Inc rose 2.1 percent to 3,480 yen and Sony Corp advanced 3.2 percent to 2,780 yen.
Komatsu, the world's second-largest maker of construction machinery, gained 2.9 percent to 1,632 yen and Hitachi Construction Machinery Co added 3.1 percent to 1,766 yen.
Bridgestone, Japan's top tyre maker, shot up 5.6 percent to 1,785 yen after it raised its full-year outlook again after a surprise upgrade in June, citing costs cuts.
Some 2 billion shares changed hands on the Tokyo exchange's first section, slightly below last week's daily average of 2.1 billion.
Advancing stocks outnumbered declining ones by more than 3 to 1.
