(Bloomberg) — Japanese stocks suffered their biggest three-day drop on record in early August, wiping $1.1 trillion from their market value, giving bullish investors another reason to buy into one of the hottest trades of 2024.
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The hardest hit were the fastest-rising stocks, which saw their prices fall to more attractive levels.The valuation improvement campaign that had boosted Japanese stocks’ international appeal has come to a halt, removing some of the froth from a market that’s now worth $6.1 trillion.
The Bank of Japan surprised traders last month with a surprise interest rate hike, but the central bank later said it would not tighten policy too quickly to roil markets further, limiting a sharp rise in the yen and removing a major threat to stock market gains.
Among the major global catalysts, the latest U.S. labor market data helped ease concerns about whether the Federal Reserve is easing monetary policy quickly enough to avert a potential recession, while the world’s largest technology companies are stoking their plans to spend billions of dollars on artificial intelligence infrastructure.
“There has not been a major economic or financial crisis,” said Tetsuro Ii, chief executive officer of Commons Asset Management, adding that it will probably take just two or three months for markets to fully recover. Investors now recognize that Japanese and U.S. monetary policy has “entered a new phase,” and they are taking that as a signal to unwind overcrowded positions.
The benchmark Tokyo Stock Price Index (TOPIX) has fallen 12% since the end of June. Stocks that performed well earlier this year have been hit harder. While AI has been the main driver of this year’s rise, MSCI’s index of domestic semiconductor-related stocks has fallen 25% over the same period. An index of bank stocks, which had surged on hopes of higher interest rates, has fallen 16%.
“I wouldn’t call it a bubble, but the market just got carried away,” said Toru Yamamoto, chief strategist at Daiwa Asset Management Co. “When risk needs to be reduced, the most inflated positions will be reduced.”
Japan has become one of global investors’ favourite markets this year on expectations that inflation will return after more than two decades of sluggish prices and that Japanese companies will return more cash to shareholders at the urging of the Tokyo Stock Exchange.
A recent sell-off has made the shares cheaper, which could make them more attractive to foreign investors such as Warren Buffett, who has been pouring money into the Japanese trading company.
The Tokyo Stock Exchange index currently trades at 13 times expected forward earnings, compared with 20 for the S&P 500. The Japan stock index has fallen to 21 times, down from 35 times at the start of the year.
“It seemed like stock prices had risen a little too much last month, but selling has brought them back to the level they should be,” said Masayuki Murata, head of the balanced portfolio investment department at Sumitomo Life Insurance Co. At the current valuation, “I’d say we’re at a bargain-hunting level.”
In the derivatives market, sentiment towards Japan remains positive, with bullish call open interest on the Nikkei growing faster than bearish puts, causing the put/call ratio to fall to its lowest in nearly six and a half years, suggesting widespread betting on a market recovery.
Risks remain, particularly a stronger yen as the Bank of Japan tightens monetary policy and the Fed eases. A weaker yen would boost overseas profits for Japanese exporters, sending the yen to its lowest level in decades and boosting stock prices.
Geopolitical tensions between Washington and Beijing, which dampened tech stocks’ momentum last month, are still playing a role, especially with the U.S. presidential election looming.
The Nikkei Volatility Index, Japan’s version of the “fear index,” closed at 45 on Friday, down from Monday’s intraday spike of 85 but still well above its long-term average of around 22.
For Ben Bennett, head of Asia investment strategy at Legal & General Investment Management, the crowded positioning in Japanese stocks is a reason to avoid them.
“The question is whether this excess position has been significantly reduced,” he said. “It will likely take more than a few days of volatility to bring this position back to neutral. If anything, I think investors who are bullish on Japanese stocks may increase their positions given the recent weakness.”
For Sumitomo Mitsui Banking Corporation Managing Director Arihiro Nagata, the recent turmoil came as no surprise, given the high levels of pressure the market is under.
“I think they’re waiting for some kind of trigger to cause a correction,” he said. “It was hard to predict, but I think positions were lightened and the market became cheap.”
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