* Nikkei up 0.3 pct by midafternoon
* Retail investors returning to market -fund manager
By Antoni Slodkowski
TOKYO, Jan 19 (Reuters) - The Nikkei average rose for a third straight session on Wednesday, inching towards recent eight-month highs as a mostly upbeat start to the U.S. earnings season lifted expectations for Japanese firms to show further recovery.
Target price hikes for Google and earth-moving equipment maker Caterpillar have bolstered hopes that the world's No.1 economy is on a sustainable recovery path and sent U.S. stocks higher, despite weak results from Citigroup.
The Nikkei has climbed 3 percent this year and is up 15 percent since the start of November after many foreign investors changed their stance on laggard Japanese stocks to neutral from underweight.
"Retail investors are joining foreigners, but they are mostly buying small and mid-size cap shares, concentrating on news for particular sectors or individual companies," said Hiroaki Osakabe, a fund manager at Chibagin Asset Management.
Analysts said such a buying pattern was behind a surge in textiles, which outperformed other sectors with a rise of 2.5 percent helped by an across-the-board hike in share price targets by Goldman Sachs on attractive valuations.
Toray Industries Inc, Japan's largest maker of synthetic fibres, jumped 4.1 percent to 553 yen and Teijin Ltd surged 5.3 percent to 416 yen.
The trend was also reflected in a jump in property-related shares after a similar sector-wide hike in share price targets by Nomura Securities on Tuesday.
"This pattern will likely stay unchanged for a while, pushing upgraded stocks and individual sectors higher on high volume," said Masayuki Otani, chief market analyst at Securities Japan, Inc.
"But advances in the whole index are limited as investors consolidate around new levels and slowly brace for a small correction, which may be triggered once all positive factors linked to robust earnings disappear after companies have reported later this month."
By midafternoon the benchmark Nikkei was up 0.3 percent or 32.53 points at 10,551.50.
Resistance now looms at 10,620.57, an eight-month peak marked last week, market players said. If that level is breached, the next target investors are eyeing is 10,638.23, a high hit in May last year.
The broader Topix index added 0.4 percent to 935.32.
SMELTERS ADVANCE
Non-ferrous metals smelters were also among the Nikkei's top gainers, with the sector index adding 2.1 percent as copper rose close to record highs on Tuesday.
Sumitomo Metal Mining gained 4.3 percent to 1,447 yen and Dowa Holdings climbed 4.4 percent to 588 yen.
Market participants said foreign buying is set to continue on expectations Japanese companies will show further improvements in their October-December earnings, but also stressed that earnings are still well below pre-financial crisis levels.
"The 300 companies that best represent the Japanese economy would have to post year-on-year increases of up to 14-15 percent to seriously beat market expectations," said Kazuhiro Takahashi, general manager at Daiwa Securities Capital Markets.
Market will also look for news about how well-prepared the firms are to sustain an earnings recovery in the long run. Chibagin's Osakabe mentioned cost control, structural changes, exposure to growing Asian markets and foreign currency hedging as key focal points for the market.
Social network and gaming company Gree was up 2.2 percent at 1,159 yen after announcing on Tuesday it would go into the smartphone ad network business, connecting advertisers with websites that want to run advertisements. (Editing by Michael Watson)