Nov. 20 (Bloomberg) -- Investors should sell Japanese stocks and buy government bonds as deepening deflation caused real interest rates to diverge from stock prices for the first time in 18 years, according to MU Investments Co.

The CHART OF THE DAY shows real interest rates, derived by subtracting inflation rates from yields on 10-year government bonds, have risen since the beginning of this year, while the Topix index, a benchmark equities gauge, lagged behind. Consumer prices, excluding fresh food and energy, slid 1 percent in September, the steepest fall since May 2001.

“Under Japan’s deflationary environment, investors will probably be better off by selling stocks and buying government bonds with short maturity for income gains,” said Hiroshi Morikawa, a senior strategist at Tokyo-based MU Investments. October’s consumer price data is due Nov. 27, leaving real interest-rate data through September, the trend will be little changed in upcoming reports, he said.

Returns on 10-year government notes climbed to 1.475 percent on Nov. 9, a level not seen in five months on concern debt sales will rise, data compiled by Bloomberg showed. Last month, state agencies proposed in initial budgets to spend a record 95.04 trillion yen ($1.07 trillion) in the fiscal year from April 1, even as Japan posted a shortfall in corporate taxes for the first time on record in a first-half period.

“Interest rates are rising not because of expectations for an economic recovery but because of concern the budget deficit will worsen,” said MU’s Morikawa.

Japan’s debt burden is approaching 200 percent of gross domestic product, the Organization for Economic Cooperation and Development estimates, as the government pledged cash to child- raising families and lower school tuition. Falling wages and a worsening job outlook are discouraging consumers from spending, prompting companies to cut prices.

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To contact the reporter for this story: Masaki Kondo in Tokyo at mkondo3@bloomberg.net; Satoshi Kawano in Tokyo skawano1@bloomberg.net.

Last Updated: November 19, 2009 19:14 EST