The stock index Nikkei 225 fell more than 12% on August 5 and recovered 10% the next day. On August 7, the yen weakened more than 2% after the Bank of Japan said it would not raise rates as long as markets were unstable, following an earlier rise in the yen and an impact on carry trades. The past one was a truly exceptional week for Japanese markets, which nevertheless remain interesting according to experts.
“What we have seen in the last few days on the Japanese stock market is undoubtedly a “historic” moment in terms of volatility level – explains Daisuke Nomoto, Global Head of Japanese Equities at Columbia Threadneedle Investments – What is interesting is that this extraordinary spike in volatility has occurred despite the fact that the Japanese and global financial system is quite solid and has no liquidity or solvency problems”.
What happened
On July 31st the Bank of Japan announced two policy changes: the first was to raise the benchmark rate from 0.1% to 0.25%, the second was to halve the amount of monthly government bond purchases over the next two years, to about 3 trillion yen from the current 6 trillion yen. Both measures appeared to be in line with market expectations, and the reaction from Japanese stock and bond markets was initially muted, while the yen continued to strengthen.
Subsequently, however, weak earnings results were announced by some major companies. US technology companieswhich sent the SOX semiconductor index plummeting. At the same time, weak data on theemployment in the United States has increased recession fears, further accelerating the sell-off in global stock markets, with Japan being hit the hardest.
The correlation between stocks and the yen
“Historically, the Japanese stocks are negatively correlated with the performance of the yen – says Nomoto – In other words, a weaker yen is good for the stock market and vice versa. So, one of the main factors that contributed to the recent market crash was the strong rise of the yen. In particular, one piece of data suggests that net short positions on the yen have fallen sharply by about 50% from their peak a month earlier. This highlights how the significant unwinding of the carry trade has occurred in a rather short period of time. At the moment, it is still a “glass half full, half empty” situation, but we believe it is reasonable to think that the most significant phase of the unwinding of short positions on the yen is almost behind us”.
As a rule of thumb, the expert points out, the sensitivity between Japanese corporate earnings and the movement of the yen is about 0.5; in other words, for every 10 yen of appreciation, corporate earnings can fall by about 5%. In the last three weeks, since mid-July, the yen has appreciated by 15 yen against the U.S. dollar, but in the same period the stock market has fallen by nearly 25%.
“If historical sensitivity had held, corporate earnings would have fallen by 7-8% and so the stock market would have fallen by about the same amount,” says the analyst at Columbia Threadneedle Investments. “However, stocks have fallen by 25%, which seems to be a overreaction from the perspective of currency market volatility. I would like to point out that the current exchange rate of 147 yen is still much weaker than the historical range of 100-125 yen over the past ten years (which lasted until 2022). The outlook for the dollar/yen ratio in corporate earnings forecasts is around 140-145 this year, which means that the current exchange rate is neither too positive nor too negative compared to corporate earnings forecasts and that some confusion can still be expected. However, we are convinced that fundamentals and company valuations will ultimately prevail.”
Still interesting ratings
“From a valuation perspective, Japanese stocks still look attractive to us. – he adds – Given the recent correction, the P/E ratio is low, while the P/B ratio is 1.2x, one of the lowest levels among major equity markets globally. In fact, over 30% of Japanese listed stocks are still trading at less than 1x book value. Furthermore, the dividend yield of almost 3% is attractive, but more importantly we would like to point out that there are few major equity markets in the world where the dividend yield is higher than the prevailing long-term bond yield. While we are currently focused on company-level valuations, the Japanese equity market certainly remains a good place to fish from a valuation perspective.”
Furthermore, “corporate governance reform has forced Japanese companies to focus on returns and capital efficiency, which are key to generating long-term shareholder value. Second, the shift from deflation to inflation is in many ways a disruptive change, as the normalization of economic and business activity will have a positive impact on the family sector and even on the fundamental values of people”.
