How to Respond When Japan’s Market Loses Its Head
Why is the Nikkei setting single-day records for points lost and gained? After-the-fact explanations don’t explain it all away.
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It’s been wild sailing in heavy seas for Japanese stocks after last week’s flash crash. But the markets appear to have regained some sense of calm.
In my last column, I explained that the selling was overdone, and didn’t make total sense. As I was writing last Tuesday, the Topix and Nikkei 225 were rallying. The Nikkei ended up adding more points than it ever had in a single day — 3,217.46 to be exact — and advancing 10.2%, its biggest one-day percentage gain since October 2008.
The Topix tracks the whole market, and ended with a 9.3% hike, redressing some of the shocking 12% both indexes had lost the previous day.
Tuesday’s trading has continued the recovery story, with the Nikkei up 3.5%. The Topix added 2.8%. Those would be very strong days were it not for the recent crazy moves.
After all that, Japan stocks are up 7.4% for 2024, in the form of the Topix. But they’ve lost any of the fervor that they have had essentially since the start of last year.
I attributed the massive selling to the unwinding of the carry trade that has seen global investors borrow in super-cheap yen, then in some cases make far riskier bets on U.S. tech stocks. With the Artificial Intelligence rally on Wall Street losing some hot air, it took a minuscule raising of Japanese interest rates to start the dual process of undoing that play.
Ever since Japan started the trend of negative interest rates back in 2016, yen borrowing has been highly attractive. And it still is. Let’s not forget that Japanese rates are now 0.25%, as of the last move on July 31. Contrast that with European interest rates at 4.25%. Contrast that with British rates on the pound, now at 5.0%. And of course contrast that with U.S. interest rates still standing at 5.5%.
So Japan raising rates 15 basis points, the last move, is hardly earthshaking. OK, the Bank of England cut 25 basis points as of August 1, at much the same time. But that’s moving them lower from a 16-year high. The Fed hasn’t even started cutting yet, and markets front-run and second-guess that.
I took some stick for quoting Paul Krugman in a recent column but I enjoy the perspective that the Nobel Prize-winning economist provides. And there was a healthy dose of that in his last newsletter, although it’s paywalled only for subscribers to The New York Times.
I’ll summarize it in a couple of paragraphs, though it’s worth a read. It’s titled “Market Crashes Happen. They Don’t Necessarily Mean Much.”
His point is that on Black Monday back on October 19, 1987, the Dow Jones Industrial Average fell a cataclysmic 22.6% in one day. Then commentators rushed to offer explanations. Recession fears, geopolitical tensions and so on. But when Robert Shiller surveyed market participants while the crash was in progress, participants cited precisely none of the justifications later offered for the crash.
They were selling because others were selling. Prices were going down. So … sell. “In other words, the stock plunge looked like a panic that fed on itself," Krugman maintains.
Of course, Shiller also won the Nobel Prize for economics, for his work on the irrationality of markets. He shared that prize with Eugene Fama, famed for his theories that financial markets are highly rational and efficient. The Nobels are not known for their stand-up comedy routine, but that’s about as close as they come to a drop-the-mic punchline.
Why did this selling start? On the one hand, we have economists warning that investors are concerned about potential U.S. recession.
But c’mon. Are we really worried about that? We entered this year with pundits singing a similar tune. Those recession fears soon evaporated, particularly when Nvidia NVDA and other Magnificent Seven shares went on a bull run.
Are you currently worried that there will be a U.S. recession? And even if you are, would that cause you to jettison your portfolio?
And, even if investors are fretting about the U.S. economy, why would the selling be even heavier in Japan?
The Japanese economy is humming a very faint tune but humming along nevertheless, looking at real growth of 1.0% for fiscal 2025 and 2026, according to the central Bank of Japan. Corporate profits are up. Inflation has achieved the 2.0% rate the central bank would like to see. Companies have been able to raise prices slightly and the situation appears benign.
There hasn't been any significant change in that outlook. The outlook, despite stormy markets, is for fine weather.
The strange thing about Black Monday back in 1987 is that it didn’t spill over into economic doom. Such a sudden selloff that we experienced in the last 7-10 days also shouldn’t spill over into the U.S. or Japan economies.
Of course, a sustained stock selloff would hurt in the end. But that’s why I find the last week of trading and decent recovery in Japan stocks encouraging. The Nikkei and Topix have lost their froth but are still up this year.
Why did last week’s crash and then rally returning half the losses and then some happen? Yes, the yen carry trade is unwinding. But someone started the selling, and others followed. It’s noteworthy the selling was heaviest in Japan, where trading is dislocated from U.S. markets. So some of the sellers were operating in an information vacuum, at least about U.S. market moves and the tech selldown.
Continue to watch this space. But it would be dangerous to make large portfolio adjustments on the back of an extremely bad day for Japanese equities, followed by a hefty rebound. The sellers were shaken out, for the time being, and normal service has resumed.
