Japan’s stock markets plunged to an eight-month low on Friday, following a consecutive two-day decline triggered by the Bank of Japan’s decision to raise benchmark interest rates to their highest level since 2008.
The Nikkei 225 fell sharply by 5.81%, closing at 35,909.7, its most significant drop since March 2020, and falling below the 36,000 mark for the first time since January, according to FactSet data. Meanwhile, the broader Topix index suffered an even steeper decline of 6.14%, ending the day at 2,537.6, marking its worst performance in eight years.
This recent downturn contrasts sharply with the market’s performance less than a month ago, when the Nikkei reached an all-time closing high of 42,224.02 on July 11.
Bruce Kirk, Chief Japan Equity Strategist at Goldman Sachs, discussed the market’s volatility on CNBC’s “Squawk Box Asia.” Kirk characterized the current market conditions as a “transitional phase,” noting that while the situation is challenging, it reflects a broader fundamental shift rather than a broken rally.
“We don’t think the rally story is broken,” Kirk said. “However, the narrative is definitely evolving, which is likely to result in continued volatility and aggressive sector rotation.”
Kirk attributed the previous rally to three key factors: yen depreciation benefiting blue-chip exporters and banks, expectations of monetary policy normalization, and corporate governance reforms. Japan’s markets had been the top performers in Asia last year and up until June of this year.
“The rules of the game have definitely changed, particularly regarding rates and foreign exchange,” Kirk explained, highlighting that investors are currently reassessing their sector positions in response to these changes.
Despite the current market turbulence, Kirk identified a positive trend: renewed investor interest in Japan’s small- and mid-cap companies. This shift is driven by these companies’ higher exposure to domestic demand and reduced susceptibility to foreign exchange fluctuations.
“For the first time in about three years, there is notable interest in Japan’s small and mid-caps,” Kirk said. “Investors are increasingly focusing on areas with more domestic demand.”
Kirk offered two potential explanations for the ongoing market reassessment following the BOJ’s rate hike. The first is skepticism about Japan’s economic resilience to a 25 or 50 basis point rate increase and concerns over Japanese corporations’ profitability with the yen trading below 150 against the dollar. Currently, the yen is trading at 149.4, having fallen below the 150 mark since the BOJ’s decision on Wednesday.
The second explanation relates to the market’s crowded nature, where a concentrated investment in a narrow group of companies has led to sharp pullbacks when fundamental conditions change.
“Everyone is on the same side of the boat when fundamentals shift, leading to aggressive pullbacks and reversals,” Kirk noted.
Regarding the duration and intensity of the current pullback, Kirk observed that over the past two years, the market has experienced around seven “momentum pullbacks,” each resulting in a 7% to 8% decline from peak to trough, with recovery typically taking about two months.
He likened the current market conditions to those observed in December 2022, when the BOJ adjusted its yield curve control policy.
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