Has Japan’s Stock Market Peaked? Navigating the Latest Developments

20 Jun 2024

By Danish Lim, Investment Analyst, Phillip Nova

 

  • Much of the surge in Japanese equities have been powered by currency-sensitive exporters like Toyota, which have benefitted from a weaker yen.
  • We note that the weaker currency has resulted in higher imported inflation and negatively impacted consumption. The correlation between a weaker yen and stronger stock prices started turning flat once the yen depreciated past ¥155/$
  • The next leg of this rally could be driven by domestic demand-oriented stocks; provided yen depreciation eases and wage growth is able to keep up with inflation.
  • Delayed BOJ rate hikes and delayed FOMC rate cuts should eventually translate into an easing of yen depreciation pressure- supporting a Yen rebound and enabling Japanese equities, particularly domestic demand-linked stocks, to outperform in 2H 2024.
  • We see current weakness as an entry opportunity. Our technical setup has a risk-reward ratio of 2.03x.

 

Our View:

The SGX Nikkei 225 Index Futures contract slumped in April (-5.03%) and was nearly flat in May (-0.05%) as the rise in 10-year JGB yields following the BOJ’s March and May meetings weighed on semiconductor/real estate names and other growth stocks.

The contract also dipped following the BOJ’s June meeting as the central bank announced it will reduce JGB purchases but postponed details such as scale and the pace of reduction until July. This uncertainty over monetary policy alongside political instability in Europe resulted in the Nikkei VIX (seen below) surging by almost 13% on 17 June.

Source: Bloomberg, Nikkei VIX, 17 June

Equities were also dragged by weakness in Toyota as the world’s largest automaker found itself embroiled in a safety scandal and had to halt some shipments.

Yen Depreciation:

We believe that domestic demand-oriented stock laggards, having been dragged down by prolonged yen weakness, could be the next key driver of Japan’s historic market rally. In terms of P/E ratio, a Ratio Analysis of the Nikkei 225 Domestic Exposure Index to the Nikkei 225 Global Exposure Index shows that the current ratio (0.78) is well below the 5-year average (1.05). Mean reversion indicates potential upside for domestic demand-linked stocks.

Source: Bloomberg, 18 June, Mean Reversion indicates potential upside for domestic-exposure stocks

Despite rising yields, due to interest rate differentials and carry trades, the Yen continued to depreciate against the Dollar. Although a depreciating currency previously helped the Nikkei 225 climb to new record highs, it has also resulted in higher imported inflation, weighing on consumption-related companies including retailers, pharmaceuticals, and private railways.

This came as several business leaders expressed concerns about the yen’s extended weakness. A survey conducted by Teikoku Databank on May 17 reported that about 64% of firms surveyed said the recent depreciation of the yen has eroded their profits, while just 7.7% saw a positive impact.

Koji Shibata, President of ANA Holdings, said that a more “comfortable” level would be 125 to the Dollar. Rival Japan Airlines President Mitsuko Tottori said an exchange rate of around 130 to the dollar would be better for the airline.

In our opinion, yen depreciation, once a key growth driver, now exerts downward pressure on the stock market through higher imported inflation. We note that the correlation between a weaker yen and stronger stock prices started turning flat once the yen depreciated past ¥155/$ (seen below).

Source: Bloomberg, 18 June, Nikkei 225 Futures (SGX), and USDJPY (Light Blue), and JGB 10Yr Yields (Orange)

Key to our outlook also depends on whether wage growth is able to keep up with inflation, helping households reverse decades of deflation mentality and consumption patterns.

Taking into account the recent soft US CPI data, we expect delayed BOJ rate hikes and delayed FOMC rate cuts to translate into an easing of yen depreciation pressure- supporting a Yen rebound and enabling Japanese equities, particularly domestic demand-linked stocks, to outperform in 2H 2024 and drive the next leg of the rally.

In the meantime, we see any near-term weakness or pullback as an entry opportunity. Corporate governance reforms should provide support for Japanese equities over the medium to long term.

Expressing Our View:

We favor the hypothetical trade setup below in order to express our view:

Long SGX Nikkei 225 Index Futures:

The daily chart shows the contract recently consolidating around the 38,000 – 39,500 level.

With a Trend-based Fibonacci Extension drawn from the October 2023 low, we prefer to take entry at around 38,430, as we view current weakness as an entry opportunity. The 14-day RSI indicates that the contract is currently not at overbought levels.

We set our target level at the 0.50% extension level around 42,035. Stop loss is set below the key support level at 36,650. This setup delivers a reward: risk ratio of 2.03x.

  • Entry Level: 38,430
  • Target Level: 42,050
  • Stop Loss Level: 36,650
  • Profit at Target: 3620 x ¥500= ¥1,810,000
  • Loss at Stop: 1780 x ¥500= ¥890,000
  • Reward: Risk Ratio: 2.03x

 

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An Exchange Traded Fund (ETF) is a marketable security that is formed to track nearly anything, ranging from a specific index, sector, commodity, or increasingly, theme. They are most commonly used to track a basket of stocks, and can typically be accessed through the same channels as regular stocks. ETFs are typically separated into passively-managed ETFs that simply mirror the security they are tracking (e.g. the STI), and actively managed ones that attempt to deliver higher returns or specific investment objectives, often with a pre-specified theme in mind (e.g. ARK Invest’s Innovation ETF).

Why should I trade in ETF CFDs?

  • ETFs have been growing in popularity over the years. 2020 was the best year for ETFs yet, with global equity ETFs seeing more than $1T in inflows within a 12-month period. Using CFDs to gain exposure to ETFs allows for greater capital efficiency because only a portion of the contract value is required as margin to establish a position.
  • ETFs are particularly popular with investors seeking a relatively hassle-free investing experience, while desiring exposure to a range of specific and relatively understandable securities. Trading ETF CFDs brings greater convenience by eliminating the need for traders to hold multiple currencies in order to access global ETFs.
  • An investor wanting exposure to the post-pandemic economic recovery could open a position in the well-known SPDR S&P 500 ETF (SPY), which tracks the performance of the S&P 500. Another investor that may be convinced of the future importance of Environmental, Social and Governance concerns (ESG) may find the increasing selection of ESG-themed ETFs that track a basket of high ESG-rating companies to be a good investment, rather than cherry-picking individual equities by hand. ETF CFDs can act as a powerful tool for traders can profit from both directions of the market by taking on long or short positions.

A look at two ETF CFDs we offer:

1) Has the ARKK been sunk?

ARK Innovation ETF (ARKK) ARKK is an actively managed ETF by ARK Invest that invests in a range of companies based on their innovative and industry-disrupting potential. ARKK’s largest holdings are in companies such as Tesla, Square, and Zoom. ARKK is down around -33% from peaking on 12th Feb and is currently in the red for the year to date as the market experiences a risk-off outflow of funds. Superstar fund manager Cathie Wood has however been consistently doubling down on her bets, buying even more shares in growth stocks that are going through their own tumultuous periods such as DraftKings, Peloton, Teladoc, and Tesla. In her view, ARKK is playing the long game, and remains steadfastly convinced in the long-term prospects of these growth stocks beyond this current bout of volatility. Similarly on outflows, investors are still betting big on ARKK as ARK Invest has only lost about $1.2B in assets this year across all its six funds, compared to seeing an inflow of $15.1B during the same period. Recently, investors have been nervously eyeing ARKK’s basket of tech stocks as their future earnings potential remain vulnerable to erosion through high inflation – the dominant concern of the market in recent weeks. As commodities – the major contributor to the recent heightened inflation fears – drops sharply from record highs, are investor concerns over hyperinflation overblown?

2) Searching for exposure to Asian equities?

iShares MSCI Asia ex Japan ETF (AAXJ) The AAXJ is currently trading -10.6% adrift of all-time highs seen in February, giving up gains in tandem with an Asia-wide equity sell-off at the time. Given that slightly over 40% of the ETF’s holdings are based in China, the ongoing tumult seen in Chinese equities currently have carried over nearly perfectly in the AAXJ, as Chinese investors take a breather after the stellar gains made over the past year. Looking ahead, Asia – and particularly China, is steaming ahead with its economic recovery. China is widely expected to be one of the best-performing major economies this year, providing a major boost to the outlook for corporate earnings. As the rest of Asia and the world gradually opens up their own economies, AAXJ is likely to again benefit from strong Asian outperformance amidst a strengthening trade outlook.

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    Unlike futures which commonly have a fixed expiration date, CFD allows traders to perpetually hold the position(s). CFD is cash settled, no need to worry about the delivery of the underlying asset.

 

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