Navigating Volatility in Japan; LT Fundamentals Unchanged
By Danish Lim Zhi Lin, Investment Analyst
Current Performance of SGX Nikkei 225:
The Nikkei 225 Index plunged -12.40% on 5 August, its steepest single-day decline since 1987. Investors fled equities as a stronger yen hammered export stocks, tighter monetary policy led to an unwinding of carry trades, US recession fears, and a rotation out of Tech amid “AI bubble” concerns.
While the decline was broad, Tech was particularly hard hit, with stalwarts like Softbank Group (-18.66%) and Tokyo Electron (-18.48%) down by nearly 20%. This is important as Tech has roughly a 49% weightage in the Nikkei 225 index, meaning a decline in Tech has an outsized effect on the index.
Nevertheless, the index rebounded on 6 August. The SGX Nikkei 225 Index Futures contract rallied by 9.21%. We attribute this rebound to strong overnight US Services data that provided comfort economic growth could hold, easing recession fears.
Thus, it seems apparent that US recession fears will take center stage moving forwards
Dovish BOJ
On 7 August, the SGX Nikkei 225 Index closed up by 1.19% as BOJ deputy governor Shinichi Uchida sent a dovish signal to markets, likely with the intention of stemming panic selling. He stated that recent market moves were “extremely volatile” and that they won’t raise rate when the market is unstable. Uchida added that the US economy is likely to have a soft landing and that the rate trajectory will shift if market moves affect the overall.
Currency stability, US recession, and market volatility, are all key factors that will determine the path ahead for Japanese equities. The BOJ will likely proceed with more caution for future rate decisions.
Unwinding of Carry Trades
The elephant in the room is the ongoing unwinding of carry trades. A carry trade typically involves borrowing the lower-yielding yen and investing that borrowed money into higher yielding assets.
Because of the BOJ’s recent rate hike which led to yen appreciation, and the potential for more rate cuts by the Fed due to recession fears, carry returns have seen a decline as interest rate differentials narrow.
As carry trades get liquidated, traders will have to buy back yen to repay loans taken to fund the carry trade, traders may also sell off assets, including stocks, to cover their positions.
Positives
On the bright side, recent data showed an increase in real wages for the first time in 27 months. This could have contributed to the rebound in Japanese equities as traders saw hope that a virtuous wage-price cycle could emerge to support consumer spending and sentiment.
Japanese households have also poured 7.5 trillion yen (52b) of funds into new tax-free investment accounts called NISA during 1H 2024, according to Japan Securities Dealers Association. Should costs ease and real wages continue to grow, we expect domestic demand recovery to be the next key growth catalyst for Japanese equities.
However, over the coming months, until recession fears recede and USD/JPY stabilizes, Japanese equity momentum could be limited due to the re-pricing of recession risks and the unwinding of carry trades.
Nikkei 225 Outlook & Trading Opportunity:
Volatility is likely to remain elevated due to the unwinding of carry trades and US recession fears which we believe are in the process of being priced-in.
With the selloff bringing prices back down to more reasonable levels, we could see dip-buying provide temporary support to the market.
Expressing Our View:
We maintain our trade setup below to express our view:
Long SGX Nikkei 225 Index Futures
Based on a Fibonacci Retracement drawn from the October 2023 low to the July high, the 4 hourly chart shows the contract having broken below the 0.786% retracement level before bouncing back to around the 0.618% level at around 35,000 as of market close on 7 August. Based on the Moving Average Convergence Divergence Indicator (MACD), we maintain a long bias on the contract as:
- The MACD line is shown to have crossed over the signal line.
- The MACD histogram is also in positive territory.
Entry is set at assumed market price of 34,850, although we prefer to enter on dips. We favour a 5% trailing stop loss to protect gains and limit losses amid elevated volatility. This brings us to a trailing stop at ~33,100 (roughly 5% below market price).
We see near-term resistance near the 50-day moving average and 0.500% retracement level at 36,435. If this level is breached, the contract could push higher to the 0.382% retracement level at near 37,870.
• Entry Level: 34,850 (Market)
• Target Level: 37,870
• Stop Loss Level: 5% Trailing Stop loss at 33,100
• Profit at Target: 3020 x ¥500= ¥1,510,000
• Loss at Stop: 1750 x ¥500= ¥870,000
• Reward: Risk Ratio: 1.73x
Trade Nikkei 225 at only 50 cents* now
Capitalise on the Nikkei 225’s movements—trade SGX Nikkei 225 Index Futures at only 50 cents* now and stand to win a pair of air tickets to Japan. Learn more here.
*For applicable terms and conditions and a full risk disclaimer, please refer to phillipnova.com.sg. This ad has not been reviewed by MAS
Current Performance of SGX Nikkei 225:
The Nikkei 225 Index plunged -12.40% on 5 August, its steepest single-day decline since 1987. Investors fled equities as a stronger yen hammered export stocks, tighter monetary policy led to an unwinding of carry trades, US recession fears, and a rotation out of Tech amid “AI bubble” concerns.
While the decline was broad, Tech was particularly hard hit, with stalwarts like Softbank Group (-18.66%) and Tokyo Electron (-18.48%) down by nearly 20%. This is important as Tech has roughly a 49% weightage in the Nikkei 225 index, meaning a decline in Tech has an outsized effect on the index.
Nevertheless, the index rebounded on 6 August. The SGX Nikkei 225 Index Futures contract rallied by 9.21%. We attribute this rebound to strong overnight US Services data that provided comfort economic growth could hold, easing recession fears.
Thus, it seems apparent that US recession fears will take center stage moving forwards
Dovish BOJ
On 7 August, the SGX Nikkei 225 Index closed up by 1.19% as BOJ deputy governor Shinichi Uchida sent a dovish signal to markets, likely with the intention of stemming panic selling. He stated that recent market moves were “extremely volatile” and that they won’t raise rate when the market is unstable. Uchida added that the US economy is likely to have a soft landing and that the rate trajectory will shift if market moves affect the overall.
Currency stability, US recession, and market volatility, are all key factors that will determine the path ahead for Japanese equities. The BOJ will likely proceed with more caution for future rate decisions.
Unwinding of Carry Trades
The elephant in the room is the ongoing unwinding of carry trades. A carry trade typically involves borrowing the lower-yielding yen and investing that borrowed money into higher yielding assets.
Because of the BOJ’s recent rate hike which led to yen appreciation, and the potential for more rate cuts by the Fed due to recession fears, carry returns have seen a decline as interest rate differentials narrow.
As carry trades get liquidated, traders will have to buy back yen to repay loans taken to fund the carry trade, traders may also sell off assets, including stocks, to cover their positions.
Positives
On the bright side, recent data showed an increase in real wages for the first time in 27 months. This could have contributed to the rebound in Japanese equities as traders saw hope that a virtuous wage-price cycle could emerge to support consumer spending and sentiment.
Japanese households have also poured 7.5 trillion yen (52b) of funds into new tax-free investment accounts called NISA during 1H 2024, according to Japan Securities Dealers Association. Should costs ease and real wages continue to grow, we expect domestic demand recovery to be the next key growth catalyst for Japanese equities.
However, over the coming months, until recession fears recede and USD/JPY stabilizes, Japanese equity momentum could be limited due to the re-pricing of recession risks and the unwinding of carry trades.
Nikkei 225 Outlook & Trading Opportunity:
Volatility is likely to remain elevated due to the unwinding of carry trades and US recession fears which we believe are in the process of being priced-in.
With the selloff bringing prices back down to more reasonable levels, we could see dip-buying provide temporary support to the market.
Expressing Our View:
We maintain our trade setup below to express our view:
Long SGX Nikkei 225 Index Futures
Based on a Fibonacci Retracement drawn from the October 2023 low to the July high, the 4 hourly chart shows the contract having broken below the 0.786% retracement level before bouncing back to around the 0.618% level at around 35,000 as of market close on 7 August. Based on the Moving Average Convergence Divergence Indicator (MACD), we maintain a long bias on the contract as:
- The MACD line is shown to have crossed over the signal line.
- The MACD histogram is also in positive territory.
Entry is set at assumed market price of 34,850, although we prefer to enter on dips. We favour a 5% trailing stop loss to protect gains and limit losses amid elevated volatility. This brings us to a trailing stop at ~33,100 (roughly 5% below market price).
We see near-term resistance near the 50-day moving average and 0.500% retracement level at 36,435. If this level is breached, the contract could push higher to the 0.382% retracement level at near 37,870.
• Entry Level: 34,850 (Market)
• Target Level: 37,870
• Stop Loss Level: 5% Trailing Stop loss at 33,100
• Profit at Target: 3020 x ¥500= ¥1,510,000
• Loss at Stop: 1750 x ¥500= ¥870,000
• Reward: Risk Ratio: 1.73x
Trade Nikkei 225 at only 50 cents* now
Capitalise on the Nikkei 225’s movements—trade SGX Nikkei 225 Index Futures at only 50 cents* now and stand to win a pair of air tickets to Japan. Learn more here.
*For applicable terms and conditions and a full risk disclaimer, please refer to phillipnova.com.sg. This ad has not been reviewed by MAS
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