How specialty financing can help investors ride out Japan’s stock market volatility

17 September 2024

The recent bout of volatility in global equity markets is a reminder of the benefits of a long-term view of an investment portfolio. Securities-based financing can help investors who don’t want to be caught out by similar short-term moves in the future.

On August 5th, 2024, Japan’s benchmark Nikkei 225 stock index suffered its largest single-session drop since the global market crash of 1987 known as “Black Monday.” But the next day, the index recorded its largest single-day gain since 2008, and proceeded to inch higher into September. This recent volatility appears to have resulted in a shake-out of short-term and speculative investors, while those with a long-term horizon appear intent on standing firm, observed Yue Bamba, Blackrock’s Head of Active Investments for Japan, in an interview with Nikkei Asia.^[1]

Figure: The Bank of Japan’s rate hike had a short, sharp impact on stocks

Image source:  https://asia.nikkei.com/Spotlight/Market-Spotlight/Japan-stock-volatility-chased-away-speculators-lured-long-term-investors

The Nikkei’s plunge in August resulted from a rapid unwinding of the largest “carry trade” the world has ever seen. In a carry trade, an investor borrows in a currency with low interest rates and reinvests the proceeds in higher-yielding assets elsewhere. In this case, investors were borrowing in yen and investing in assets in other currencies, such as US tech stocks.

After the Bank of Japan surprised observers by raising interest rates in July to levels unseen in 15 years,^[2] alongside the increasing prospect of imminent rate cuts by the US Federal Reserve,^[3] the yen has strengthened sharply, narrowing the arbitrage potential of the yen carry trade. This prompted speculators who financed their trades with borrowed yen to dump their positions, driving down stock prices globally. In Japan, concerns that a stronger yen would hurt exports also hit local stocks.

The decline was exacerbated because many retail investors who had bought equities on margin – which accounts for about 70% of retail trading value in Japan^[4] — were forced to sell as prices plunged. Margin trading shrank considerably in the aftermath of Japan’s stock market turmoil.^[5]

But while short-term and margin-dependent investors were exiting the Japanese market, domestic institutional investors took the opportunity to snap up 794.2 billion yen (US$5.5 billion) of local stocks at a bargain in the week ending August 9th, according to Tokyo Stock Exchange data.^[6] Foreign investors also saw an opportunity, making net purchases of 495.4 billion yen of Japanese stocks that week, while retail investors were net sellers.

Steadfast in their convictions

Several analysts noted in the wake of the August 5th crash that Japan’s long-term underlying fundamentals remain sound. While the strengthening yen could hurt exporters’ profits, the central bank’s move to raise interest rates also signals its confidence in the economy,^[7] which, in turn, bodes well for domestically focused businesses. Banks could also benefit from higher rates.

“We continue to believe improvement of domestic economy is a key catalyst for Japanese equities to move higher, and we remain constructive over the medium term,” said Kazunori Tatebe, a strategist at Goldman Sachs.^[8]

More broadly, the new wave of investor optimism about Japan appears to be largely intact, at least for those with long-term horizons. Among others, analysts at Citi have maintained their bullish long-term outlook on the back of improved “micro and macro” fundamentals.^[9] These include resilient corporate earnings despite volatility in foreign exchange markets, a lower appreciation of the yen than initially expected, a growing number of companies announcing or increasing share buybacks and signs of improved private consumption.

Morgan Stanley described the recent market chaos as an opportunity to buy Japanese stocks at attractive valuations. It sees long-term potential from four key structural changes underway in Japan:^[10]

• The economic recovery, which is bolstering employment, consumption and capital spending. A relatively weak yen is also supporting exporters.
• Companies adopting investor-friendly reforms, including increased rights for minority shareholders.
• Companies returning more capital to shareholders through higher dividends and a steep expansion of share buybacks.
• The government’s introduction of incentives for locals to buy stocks, including a program to offer tax exemptions for small investments.

Guarding against future shocks

Japanese stocks had clawed back much of their losses by September, and several fund managers see room for further gains as overseas buyers continue to return.^[11] BlackRock’s Bamba, for example, sees upside given that many global long-term investors are still underweight on the market, which could change once they have carried out their due diligence.^[12]

Also brightening the outlook for Japanese stocks, Bank of Japan officials appeared to downplay the prospects of further imminent interest rate rises while markets remain volatile.^[13]

Nevertheless, the recent performance of Japanese equities, and those elsewhere, is a reminder that valuations of long-term shareholdings can change on a dime. This volatility is especially troubling for shareholders whose wealth is highly concentrated in one or a handful of stocks.

Long-term shareholders can insulate themselves from periods of heightened volatility by using securities-backed financing to raise capital without having to sacrifice upside potential. In turbulent times like these, specialty financing provides investors a convenient way to manage their portfolios.

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[1] https://asia.nikkei.com/Spotlight/Market-Spotlight/Japan-stock-volatility-chased-away-speculators-lured-long-term-investors

[2] https://www.reuters.com/markets/rates-bonds/bank-japan-outline-bond-taper-plan-debate-rate-hike-timing-2024-07-30/

[3] https://www.cnbc.com/2024/08/21/fed-minutes-july-2024.html

[4] https://www.reuters.com/markets/asia/margin-trading-japanese-stocks-sharply-shrinks-after-market-rout-2024-08-15/

[5] https://www.reuters.com/markets/asia/margin-trading-japanese-stocks-sharply-shrinks-after-market-rout-2024-08-15/

[6] https://asia.nikkei.com/Spotlight/Market-Spotlight/Japan-stock-volatility-chased-away-speculators-lured-long-term-investors

[7] https://www.bloomberg.com/news/articles/2024-08-01/japan-s-trading-houses-see-rate-hike-as-positive-for-business

[8] https://www.japantimes.co.jp/business/2024/08/04/markets/japan-stocks-investors-long-term/

[9] https://www.investing.com/news/stock-market-news/japan-stocks-volatile-in-nearterm-but-longterm-outlook-bullishciti-3587996

[10] https://www.morganstanley.com/ideas/stock-market-crash-2024-japanese-stocks

[11] https://www.morningstar.co.uk/uk/news/252979/after-the-crash-where-next-for-japan-investors.aspx

[12] https://asia.nikkei.com/Spotlight/Market-Spotlight/Japan-stock-volatility-chased-away-speculators-lured-long-term-investors

[13] https://www.ft.com/content/32f14625-56e3-49a3-a47d-e6651aeebcc9