What’s Really Driving Japan Stocks as Tokyo Rebounds From Worst Fall Since 1987

Japanese stocks have been hemorrhaging red ink after last week’s interest-rate hike. How far can the Tokyo market fall?

The Nikkei 225 shed a shocking 12.4% on Monday, having already dropped 8.2% since last Wednesday’s move by the central Bank of Japan (BOJ).

We’ve seen a whipsaw rebound on Tuesday, with the Nikkei up as much as 11.0%, although that’s been trimmed to 8.7% at the time of writing, and the Topix gaining as much as 10.9% before settling back to an 8.5% advance.

Phew. These are massive, baffling moves.

Monday was the blue-chip Nikkei’s worst day since the 1987 crash, when Black Monday selling globally hit Tokyo on October 20. I actually had to do a double take to confirm the numbers when they first crossed my screen.

It means a market that was setting all-time highs for the first time since the bubble days of the late 1980s was in full bubble-blowing-up mode once again. Before Tuesday’s correcting single-day “bull run,” the Tokyo market was looking at a loss for the last 12 months of trade. And it’s been a star performer the last couple of years.

The Topix, which tracks the whole Tokyo market, was also down 12.2% on Monday to bring the three days of trade since the BOJ moved to a whopping 20.3%. The Nikkei’s total three-day loss was 19.6%, Tuesday helping to restore a little balance.

All this because the central bank increased rates by 15 bips?!

Japan’s finance minister, Shunichi Suzuki, says the government is monitoring markets with “grave concern.” But what can he do?

Government and central-bank intervention had failed to correct the multi-decade weakness in the yen, which had driven the yen to levels not seen since 1986. And it’s the currency trade that’s driving these wild moves, as I’ll explain.

There was sympathy selling for Monday’s big selloff in South Korea, where the Kospi dropped 8.8% on Monday, as well as Taiwan, this year’s star performer in Asia, which dropped 8.4% for the day. Singapore’s Straits Times Index shed 4.1% and the Australian market closed down 3.7%.

We’ve seen large correcting gains on Tuesday, but they only undo some of the damage, the biggest moves higher coming in Taiwan, up 3.0% on Tuesday in afternoon trade at the time of writing, and Korea, up 3.8%. Still, that’s not even undoing half of Monday’s damage.

None of this is justified by what’s going on in Japan.

It’s not as if the rate hike by the BOJ is big. It takes rates from a range of 0.0% to 0.1%, up to a firm 0.25%. But the move, however small, did take the markets by surprise, as I noted in writing about it in my last column. Markets don’t like surprises.

There was a 33% chance of a rate increase predicted before the BOJ decision. This is only the second increase since 2007 in a nation that, between 2016 and the first move this March, got used to negative rates. Only in March did the BOJ change that policy with a minor-note but tone-changing tweak to monetary policy, as I noted at the time.

It was more likely than not that there would be an interest-rate increase this year, however. So we got the move slightly earlier than anticipated. You can’t call it a massive shock since one-third of analysts were expecting a hike.

But of course there’s more to it than that. The selloff is magnified because what we are witnessing is an unwinding of trades on the weakness of the yen, which has finally begun to “enjoy” some strength.

Some global investors have been borrowing in virtually free-to-borrow yen to invest into higher-yielding assets, buying U.S. tech stocks in the riskiest of trades. With doubts over the magnitude of the runup in Artificial Intelligence creeping into the market, and concern about a U.S. recession, we’re seeing a massive and sudden reversal, no doubt with some forced selling of assets at whatever price those overextended investors can get.

The moves we’ve seen in the last couple of days no doubt include a hefty dose of programmed trades, triggered when the Nikkei, Topix and underlying Japan stocks move in unexpected ways. That magnifies the degree of selling and the degree of rebound.

Tokyo stocks crested to all-time highs on July 11. They were setting new high-water marks that washed away the dark days of the 1980s crash, when the Nikkei touched levels it seemed might never again be attained.

Now both banking and tech stocks are selling off hard in Tokyo. Meanwhile, the Japanese currency has quickly moved from ¥161.77 to the U.S. dollar in July, the same time Tokyo equity markets were setting records, to as low as ¥141.88.

The yen sits slightly off that point of strength as I write, just north of ¥145. Still, from peak to trough it’s a 12.3% correction in one of the world’s key currency swaps in just over three weeks.

That hurts if you’ve borrowed in yen, bought U.S. tech equities, and are seeing both the currency and equity markets work against you, and fast. There’s a massive deleveraging taking place.

“In short, not only the currency but the entire ‘value’ trade in Japan which had hijacked our market for two years is being unwound,”’ Richard Kaye, a portfolio manager with Comgest in Tokyo, told Reuters.

Softbank Group SFTBY (T:9984) plunged 18.7% on Monday, its worst one-day fall since it listed in 1998. Like the Japan as a whole, Softbank also peaked on July 11, setting a fresh record high for the first time since February 2000, but had shed 46.3% in all before an 11.0% move higher on Tuesday.

Softbank is suffering alongside Tokyo stocks but is also hurt by founder Masayoshi Son’s newfound focus on “Artificial Super Intelligence,” an investment theme he intends to pursue above all else. The selloff in AI names also hurts Arm ARM, the British chip designer that is still 89.8% held by Softbank after its initial public offering last September.

The selling is overblown — as tends to be the case with dramatic market swings. Kirk Boodry, an analyst with Astris Advisory, noted to Bloomberg that the last time Softbank traded in this manner was the “capitulation trade when Covid fears swamped markets, and the discount to net asset value was almost 70% at one point.” It’s around 57% now.

Economists are climbing over themselves to heap blame for this selloff at the door of the BOJ. But where were they Tuesday last week when there was a 33% chance of this move? I didn’t hear any of that kind of criticism.

I’ve seen some pundits try to tie the poor U.S. jobs numbers last Friday into the Japan selloff. But how is the central bank of Japan supposed to preempt jobs reports on the other side of the Pacific? The BOJ needs to act on Japan data, not some inkling of what the jobless rate in Boise or Billings or Bozeman is gonna be.

The Japanese central bank had been under huge pressure to do something to stem the slide in the yen. But when they raised rates for the first time in March, the currency actually weakened because traders were disappointed with the small size of the shift, and the messaging from BOJ Governor Kazuo Ueda that the bank would move slowly.

The BOJ is also trying to remove its supports from the market, slashing its buying of Japanese government bonds by half, and ending its purchasing of exchange-traded funds. After last week’s rate hike, economists changed their tune, with 68% predicting another rate hike in Japan to bring rates to 0.5% by year end.

There’s little chance that change will now come, at least while markets are in such turmoil. The tech selloff on Wall Street is driving much of this downturn, with worries about U.S. recession leading to forced selling there.

Yes, Ueda’s language was hawkish. But the market moves in Tokyo revolve around the carry trade and currencies rather than the minor interest-rate increase decided last week.

The Japan stock selloff is not warranted by earnings, economic conditions in Japan or what is, frankly, a small and probably necessary move to raise rates. We will have to wait for the yen carry trade to get unwound before we begin to see normalized trading in Tokyo again.

Japan stocks are collateral damage, and the BOJ an easy but unwarranted target. These massive moves stem from programmed trading and the unwinding of positions for investors who were long the Japan currency swap as well as U.S. tech stocks, and suddenly found themselves having to shift those plays into reverse.