{"id":39268,"date":"2025-03-27T09:19:21","date_gmt":"2025-03-27T01:19:21","guid":{"rendered":"https:\/\/www.phillipnova.com.sg\/?post_type=market_trends&p=39268"},"modified":"2025-03-27T17:39:32","modified_gmt":"2025-03-27T09:39:32","slug":"bullish-nikkei-faces-formidable-headwinds","status":"publish","type":"market_trends","link":"https:\/\/www.phillipnova.com.sg\/cn\/market_trends\/bullish-nikkei-faces-formidable-headwinds\/","title":{"rendered":"Bullish Nikkei Faces Formidable Headwinds"},"content":{"rendered":"

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\u7ecf\u8fc7 Pranay Yadav, Portfolio Analyst<\/span>, Mint Finance<\/strong><\/h5>\r\n

Japan\u2019s lost decades are behind us. Many long-term factors are driving resurgence in Japanese equities. Economic growth is accelerating \u2013 driven by strong domestic consumption. Radical market reforms have made Japan attractive for domestic and global investors. As a result, the benchmark Nikkei 225 set a new all-time-high after four decades.<\/p>\r\n

However, the rally is facing challenges. Tightening monetary policy, trade uncertainties, and waning impact of corporate efficiency reforms pose near-term headwinds that could push the benchmark into a correction, followed by a period of consolidation.<\/p>\r\n

BOJ\u2019s rates hikes <\/strong><\/p>\r\n

The Bank of Japan (BoJ) plays a crucial role in the performance of Japanese equities. Since 2016, the BoJ instituted negative rates to support economic growth which boosted equity markets.<\/p>\r\n

Chart 1: From 2015 to 2025, loose monetary policy boosted the Nikkei 225, but equities have stagnated since rates began rising<\/em><\/p>\r\n

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\u6765\u6e90\uff1a TradingView<\/a> <\/strong><\/span><\/em><\/p>\r\n

However, in March 2024, the BoJ hiked rates for the first time after two decades. Subsequently, rates were lifted twice, up to 0.5%, the highest since 2008. Crucially, it intends to raise rates further as part of a broader return to neutral policy rate \u2013 one that\u2019s neither too restrictive nor too accommodative.<\/p>\r\n

Chart 2: The Nikkei 225 tends to rise slightly before BoJ meetings but falls sharply afterward, especially following rate hike (2024 to Present)<\/em><\/p>\r\n

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\u6765\u6e90\uff1a TradingView<\/a><\/span><\/strong><\/em><\/p>\r\n

The BoJ is expected to hike rates by 50 basis points by end of March 2026 according to a Reuters poll<\/a><\/span><\/strong>. Two-thirds expect the next rate hike in Q3, likely in July this year. Traditionally the wage hikes in spring serve as a critical indicator for the BOJ, influencing its decision to continue raising interest rates as part of its shift towards a more neutral monetary policy. This year, many economists expect the wage hikes to match or exceed 5.1% as seen in 2024. With yen\u2019s slide halting, the BoJ will have more room to manoeuvre. Consequently, a rate hike seems likely forming additional headwinds to Japanese equities.<\/p>\r\n

Fading impact of Corporate Reforms <\/strong><\/p>\r\n

Nikkei\u2019s ascent is also thanks in part to TSE\u2019s corporate reforms. For years, Japanese equities were seen as \u201cvalue trap,\u201d dissuading investors.<\/p>\r\n

In 2023, to unlock the value trap, the TSE embarked on a campaign to enhance capital efficiency among listed Japanese firms to attract wider investment. New listing rules \u201curge\u201d firms to deploy their capital better \u2013 either through shareholder returns or CAPEX.<\/p>\r\n

These reforms were effective in the near-term, boosting key valuation metrics such as P\/B and P\/E ratios. However, the improvements from these reforms are starting to slow.<\/p>\r\n

Chart 3: Japan\u2019s Prime Market weighted average Price-to-Book ratio has fallen back to pre-reform levels over the past year (2023 to Present)<\/em><\/p>\r\n

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\u6765\u6e90\uff1a Japan Exchange Group<\/a><\/span><\/strong><\/span><\/em><\/p>\r\n

Average P\/B and P\/E ratios of the prime market firms listed on the TSE is back to pre-reform levels. The large short-term bump from these policies have faded, no longer providing an immediate tailwind.<\/p>\r\n

Chart 4:\u00a0 Japan\u2019s Prime Market weighted average Price-to-Earnings ratio has fallen back to pre-reform levels over the past year (2023 to Present)<\/em><\/p>\r\n

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\u00a0\u6765\u6e90\uff1a Japan Exchange Group<\/a><\/span><\/strong><\/span><\/em><\/p>\r\n

Tariff Risks Haunt Markets<\/strong><\/p>\r\n

Perhaps the largest near-term risk facing the Nikkei 225 is the potential for trade disruptions.<\/p>\r\n

Chart 5: Nikkei 225 daily returns show a sharp drop on the day tariffs were announced <\/em><\/p>\r\n

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\u6765\u6e90\uff1a TradingView<\/a><\/span><\/strong><\/em><\/p>\r\n

Trump has announced a steep 25% tariff on imported cars, set to take effect on April 2, a dramatic 10-fold increase from the current 2.5%. Additionally, he has raised the steel and aluminium tariffs to 25%, with no exemptions or exceptions\u2014a significant blow to Japan, one of America’s key trade and security allies. Despite Japan\u2019s trade minister Yoji Muto lobbying for relief in Washington, the U.S. has yet to offer any concessions.<\/p>\r\n

US remains Japan\u2019s largest export market, accounting for \u00a521 trillion ($140. 6 billion) in trade, with automobiles making up nearly 28% of that figure. The impending tariff spike is expected to dent Japanese exports, slash domestic production, and squeeze profit margins.<\/p>\r\n

Trade tariffs, especially those impacting some of the largest companies in the Nikkei 225 present a significant risk for investors.<\/p>\r\n

Additionally, the tariffs are likely to lead to a shrinking trade surplus for Japan which may weaken the yen and further exacerbate inflationary pressures, prompting the BoJ to hike rates.<\/p>\r\n

Nikkei 225 is Weighted Towards Exporters<\/strong><\/p>\r\n

The Nikkei 225 index is dominated by technology firms which makes up almost half of the index. This sector includes both Electronic Manufacturing firms and Software & Communications companies. Notable firms within this sector are Tokyo Electron (5.9%), Advantest (5.7%), Softbank Group (4.2%), and KDDI (2.5%).<\/p>\r\n

Chart 6: Nikkei 225 sector weightings shows large weightage towards technology firms<\/em><\/p>\r\n

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\u00a0\u6765\u6e90\uff1a <\/em>Nikkei<\/em><\/a><\/strong><\/span>;<\/strong><\/span> March 21, 2025<\/em><\/p>\r\n

Other notable categories are Consumer Goods and Materials. Consumer Goods is dominated by Fast Retailing, the single largest component of the index with a weight of 10.7%. The index is impacted substantially by trade given its heavy tilt towards manufacturing. Rising input costs from imports and reduced demand for exports can both stifle performance<\/p>\r\n

\u00a0Chart 7: Nikkei 225 Sector wise 1Y performance<\/em>.<\/p>\r\n

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\u6765\u6e90\uff1a TradingView<\/a><\/span><\/strong><\/em><\/p>\r\n

Over the past year, Finance has been one of the strongest sectors in the index. Contrastingly, Producer Manufacturing, which has a high weightage in the index, has been among the underperforming sectors. This trend is likely to continue, with trade disruptions and a slowing AI rally posing headwinds to major index components.<\/p>\r\n

CME Group Nikkei 225 Futures<\/strong><\/p>\r\n

CME Group\u2019s suite of Nikkei 225 futures provide a range of instruments to express views on Japan\u2019s benchmark equity index. Futures are available in two different contract sizes \u2013 Standard and Micro. More information on these can be found at the Nikkei 225 Futures<\/a> <\/em><\/span><\/strong>page.<\/p>\r\n

Particularly, the newly launched Micro Nikkei 225 contract presents interesting possibilities for both trading & hedging exposure. Due to the smaller size, the contract requires lower margin, boosting capital efficiency for traders. For risk managers, it allows for precise hedging, reducing unwanted residual exposures.<\/p>\r\n

A crucial use case of these futures is the expanded trading hours in the week. Investors can trade CME Group\u2019s Nikkei futures 23 hours a day, 5 days a week, significantly longer than the underlying cash market. This allows futures to be an effective overnight hedging tool.<\/p>\r\n

Chart 8: CME Micro Nikkei futures cumulative volume growth<\/em><\/p>\r\n

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\u6765\u6e90\uff1a <\/em>CME Group<\/a><\/span><\/strong><\/em>;<\/span><\/strong><\/span> Oct 2024- Mar 2025<\/em><\/p>\r\n

The Micro Nikkei futures are available both as a yen-denominated, and USD-denominated product. Both provide for compelling use-cases to hedge FX volatility.<\/p>\r\n

Investors can use the USD-denominated contract to negate any risk from movements in the yen, and trade directly using USD.<\/p>\r\n

Conversely, the yen-denominated contract can be deployed strategically to benefit from a strengthening yen.<\/p>\r\n

Technical Signal Near-Term Bearishness<\/strong><\/p>\r\n

Technical summary of Nikkei 225 index shows a bearish outlook on the 1D chart timeframe. This suggests potential downside in the near-term.<\/p>\r\n

Chart 9: Nikkei 225 technical indicator signals short-term bearish outlook<\/em><\/p>\r\n

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\u00a0\u6765\u6e90\uff1a TradingView<\/a><\/strong><\/span><\/em>\u00a0 (<\/em>1-day timeframe)<\/em><\/p>\r\n

In the longer-term (1-month timeframe) Nikkei 225 technical indicators show a bullish signal<\/p>\r\n

Chart 10: Nikkei 225 long-term technical indicator signals bullish outlook<\/em><\/p>\r\n

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\u6765\u6e90\uff1a TradingView<\/a><\/strong><\/span>\u00a0<\/em>(1-month timeframe)<\/em><\/p>\r\n

Looking at specific technical indicators, the rebound following the tariff related decline seems to be fading with MACD and RSI, signaling a weakening trend. With Nikkei 225 trading below a key support\/resistance level, strong momentum may be required to pass this level. At present, that momentum is lacking.<\/p>\r\n

Chart 11: Nikkei 225 RSI, Bollinger Bands, and MACD signal emerging bearish trend <\/em><\/p>\r\n

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\u00a0\u6765\u6e90\uff1a TradingView<\/a><\/strong><\/span><\/em><\/p>\r\n

Hypothetical Trade Setup <\/strong><\/p>\r\n

While Nikkei 225 has multiple long-term drivers that support secular growth, near-term risks are palpable. Tariff uncertainty, BoJ policy, and fading impact of the TSE market reforms support a short-term bearish view on the Nikkei 225.<\/p>\r\n

Investors can express this view by deploying a short position on Micro Nikkei (JPY) denominated futures expiring on June 13 (MNIM25). The following hypothetical trade setup provides a reward to risk ratio of 1.8x. The same view can be expressed using CME Group\u2019s standard Nikkei (JPY) denominated contract which would scale the below P&L by 10x.<\/p>\r\n

Crucially, this position\u2019s P&L is denominated in yen. The yen appreciation due to BoJ policy will further boost the USD value of this P&L, enhancing overall returns.<\/p>\r\n

Chart 12: Shorting Micro Nikkei (JPY) futures expiring in June (hypothetical trade setup)<\/em><\/p>\r\n

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\u00a0\u6765\u6e90\uff1a TradingView<\/a><\/span><\/strong><\/em><\/p>\r\n