Only two months ago, the outlook for Japanese shares had rarely looked sunnier. There was “a compelling case for long-term investment into Japanese equities,” declared June Aitken, chair of London-listed CC Japan Income and Growth Trust, one of the easiest ways for UK investors to buy into the Tokyo market.
Improving economic conditions, positive governance reforms, a much greater emphasis on capital efficiency and a relatively weak yen should all support valuations, she said. The country’s expertise in robotics, artificial intelligence and other corners of technology were a bonus.
She wasn’t alone. Mainstream investment opinion was that after many false dawns, the Japanese market was at last hauling itself out of a decades-long slump. Until last month Japan had become one of the best-performing major markets in the world, the Nikkei 225 index surging by about 50 per cent in the previous two years.
But Monday’s collapse in share prices has put paid to any complacency about the world’s third-largest economy. The 4,451-point, 12.4 per cent tumble to 31,458 was the single biggest points fall in the Nikkei ever and the largest in percentage terms since 1987.
Some of Japan’s biggest-name companies were caught up in the sell-off, with the carmakers Toyota Motor Corporation and Honda diving by 14 per cent and 18 per cent respectively and the electronics giant Sony down by 8 per cent. Another big faller was SoftBank, best known in the UK for its part-ownership of the Cambridge-based chip design group Arm Holdings, which fell by 19 per cent. Fast Retailing, which owns the Uniqlo fashion chain, was down almost 10 per cent.
The carnage followed a bad day on Friday when the Nikkei fell by 5.8 per cent. Japan is now down by more than 23 per cent in the past month, which is far greater than any other major stock market and by some definitions qualifies as “a stock market crash”. The S&P 500, the benchmark for the United States, was by mid-afternoon on Monday down by only 6.3 per cent over the same period, while the FTSE 100 was just 2.5 per cent lower.
The wobble in American technology stocks has soured sentiment. So has the dimming outlook for the US economy after the disappointment of lower-than-expected job creation on Friday. They may have been the catalyst for the sea of red ink on traders’ screens in Tokyo.
But Tokyo’s problems are more localised, analysts say, and are more to do with the dramatically strengthening path of the yen against the dollar over the past few weeks. The turning point seems to have been July 11, when benign US inflation data made the prospect of a US interest rate cut more likely, just as Japan contemplated another rise.
At the same time came rumours of currency intervention by the Bank of Japan, which seemed to put a rocket under the currency, which had been languishing at a 38-year low. By the time the central bank lifted its base rate last week, which was only the second hike in 17 years, the yen was flying higher and has now appreciated by 12 per cent from Y161.6 to Y142.3 in the past 25 days.
Suddenly, Japan’s huge exporting sector looked under pressure. A stronger yen not only makes it harder for them to compete with international rivals; it also shrinks the value of their overseas profits when converted back to their home currency.
Adding to the pressures has been the so-called yen carry trade. This is the highly popular form of arbitrage by which investors borrow in yen on cheap terms and use the proceeds to buy overseas assets including bonds and shares. The surge in the yen has forced investors to reverse these trades after incurring heavy foreign exchange losses. This has also pushed up the yen. Investors have also had to sell local assets to cover these losses.
The shift has been seismic. According to Russ Mould, investment director at A J Bell: “The Japanese currency has been a major source of global liquidity, as major market players have shorted it, borrowed against it and used that money to go for long-risk assets around the globe.” Now, “massive short positions” were being closed out, driving the yen still higher, and “creating a circle every bit as vicious as it had previously been virtuous”.
Kyle Rodda, a senior financial market analyst at Capital.com, said: “We are basically seeing a mass deleveraging as investors sell assets to fund their losses.”
The push into Japanese shares by global investors has been widespread over the past year or two. Even Warren Buffett took part, disclosing last year that he had ramped up his positions in some of the country’s big trading conglomerates, which include Mitsubishi, Mitsui and Sumitomo. Stock prices in Japan were “ridiculously” cheap, he said at the time.
Events of the past few days have now entirely wiped out gains made on Japanese stocks in the past year for domestic Japanese investors. For foreigners, the losses are partly compensated for by the stronger currency.
Another morsel of good news for global investors is that Japan makes up a relatively small part of the overall share market cake, accounting for only 6 per cent of global share values. That compares with about 40 per cent at the peak of its bubble in 1989. If the crash in share values is largely confined to Japan, the impact will be relatively modest on global investors.
Meanwhile, some investors are already starting to look for bargains in Tokyo. Joe Bauernfreund, who manages the £1 billion AVI Global Trust, a FTSE 250 member, said some of the share price falls were “devoid of fundamentals” and down to panic.
One of his investments, Nihon Kohden, a Japanese maker of defibrillators and ventilators, had the dubious distinction of being the worst performer in the Topix index, down by 24 per cent on Monday.
But Bauernfreund was sanguine, saying: “We will be adding to some of these beaten-up names over the next few days.” There were opportunities to be had from “sifting through the rubble”, he added.
The jitters may continue for a while, but the Japan recovery story still has its believers.