Japanese equities rebound after rout, Fed cut in spotlight as US recession fears spread

Market turmoil likely to continue after BOJ’s hike, the US Fed’s decision to hold rates, and mixed data about the health of the world’s largest economy.

August 06, 2024

Japanese equities rebounded by as much as 10% on Tuesday, August 6, right after a historic plunge on Monday, the worst since Black Monday in 1987 – the Nikkei 225 Index rose by 10.23% as of end day, while the Tokyo Stock Price Index (Topix) jumped by 9.3%.

A rout on Monday was closely linked to the Bank of Japan’s (BOJ) decision last week to raise its interest rate by 15 basis points (bps) to 0.25%, unwinding carry trades that used to benefit from the Japanese yen’s predictable stability, dampening previous investments into higher-yielding assets such as US equities. 

On the other hand, there was weaker-than-expected US job market data that came in last Friday, with the country’s nonfarm payrolls slowing to +114,000 month-over-month, against an expected increase of 175,000. The unemployment rate rose from 4.1% to 4.3%.

Combined with the Federal Reserve’s decision to keep rates unchanged, there are some fears that the US could fall into a recession. 

Stock markets globally plunged on Monday as investors sold off with worries that the Fed has fallen behind the curve. The Nikkei 225 fell by 12.4%; while all three major indices in the US market, including Dow Industrials, S&P 500 and Nasdaq Composite, dropped by over 2.5%.

Seema Shah, chief global strategist at Principal Asset Management (AM), wrote in a commentary that markets responded to the data with “dismay”, more than just a tinge of panic.

Amid the turmoil were disappointing tech earnings that derived from heavy investment yet slower earnings growth, particularly related to artificial intelligence (AI). Tech heavyweights including Google, Microsoft and Amazon all posted underwhelming second quarter results. The ‘Magnificent Seven’ stocks lost $800 billion in market value in Monday’s trading, according to reports.

The tech selloff hit South Korean and Taiwanese markets hard in Asia, as both are home to chip and semiconductor manufacturers along the AI value chain. South Korea’s Korea Composite Stock Price Index (KOSPI) tumbled by 8% and hit a temporary trade halt, however it recovered by 3.3% on Tuesday; Taiwan’s capitalisation weighted stock index (TAIEX) dropped by 8.5%, but recovered by 3.4% on Tuesday.  

Heron Lim, economist at Moody’s Analytics, told FinanceAsia that a recovery on Tuesday was only partial, suggesting investors are taking a second look at the fundamentals and repositioning themselves.

Pinpointing fair value is inherently difficult for AI-related stocks due to its emerging nature, he added.

“We expect continued volatility as the technology matures and profitable business models are worked out,” Lim said.

Chris Buchbinder, equity portfolio manager at Capital Group, pointed out that the selloff was most acute among momentum stocks, while a number of dividend-paying and quality companies have held up.

The segment is entering a “disillusionment” zone, where extreme reactions are upcoming in the market. “A correction in AI-related stocks was to be expected,” he commented. 

Fundamentals

The BOJ intervention saw a sharp decline in equities and a rapid appreciation of the yen, with many traders unwinding carry trades, whereas according to Ronald Temple, chief market strategist at Lazard Investment, “the big story in Japan is a multi-year inflation normalisation that is still in its early years”.

Aninda Mitra, head of Asia macro and investment strategy at BNY Advisors Investment Institute, pointed to “reasonably healthy” services and composite July purchasing managers index (PMI) in Japan, saying that there’s “little evidence” of a fundamental deterioration in the Japanese economy.

Real wages, adjusted for inflation, also grew for the first time in 27 months, Japan’s labour ministry said on August 6.

“But all that said, the underlying financial market context has grown fluid. This could reflect an ongoing unwind of overstretched positioning, such as long Japanese equities, and an over-reliance on yen funded carry trades,” Mitra said.

In the short-term, an imminent market turnaround is unlikely, given the depth of the negative narrative, said Principal AM’s Shah.

“A sustained market recovery needs a catalyst, or likely a combination of catalysts, including stabilisation of the Japanese yen, strong earnings numbers, and solid economic data releases."

In the US, markets have been increasingly anticipating a rate cut by the Fed after its upcoming September 17-18 meeting, by as much as 50 bps in case of more weak data. Meanwhile, the possibility of an emergent inter-meeting rate cut has risen.

Despite the 10-year US Treasury yields at one stage dropping to around 3.8%, compared to the 2-year yields at 3.99%, analysts said that it is still too early to fully embrace a recessionary outlook for the world’s largest economy. 

“While technical factors and forced selling are exacerbating negative sentiment, the connection between deteriorating sentiment and fundamentals has yet to be firmly established,” Jack Janasiewicz, portfolio manager and lead portfolio strategist at Natixis Investment Managers Solutions, wrote in a commentary.

Björn Jesch, global chief investment officer at DWS, echoed the view that a recession at this stage is unlikely to materialise, and even if it were to happen, it is likely to be a mild one, given the overall strength of the economy and solid private sector balance sheets. US service sector PMI numbers came in on Monday at 51.4, beating expectations.

Lim at Moody’s Analytics anticipates that upcoming US data points will show the “ongoing sound fundamentals” of the US economy ahead of September’s Fed decision. “In other words, we do not think the US economy is in recession,” he told FA.

¬ Haymarket Media Limited. All rights reserved.