Investors Take Long-Term View As Rate Hike Whipsaws Japan

(Bloomberg) -- This past week’s rate hike in Japan hammered the benchmark index the most in eight years. Despite the turmoil, some investors still have faith in the long-term outlook for the country’s stocks.

The Bank of Japan’s decision on Wednesday to raise rates to 0.25% sent a wave of volatility through the market, with the Topix jumping 1.5% on the day, only to plunge on both Thursday and Friday.  

The BOJ’s move, coupled with signals from the US Federal Reserve that it will cut rates, strengthened the yen. A weak currency had been a major factor in supporting the shares of Japan’s exporters. Still, as the country normalizes after years of negative interest rates, corporate pricing power and higher pay for workers will spur economic growth that will support the market, according to investors and analysts at Hang Seng Investment Management Ltd., Goldman Sachs Group Inc. and T. Rowe Price Group Inc.   

“The long-term underlying fundamentals remain fair,” said Wilfred Sit, director and chief investment officer at Hang Seng Investment Management Ltd. “Looking into next year, the Japanese economy can show more signs of a gradual recovery.”

Financial stocks suffered the biggest whiplash. The sector surged on Wednesday’s rate hike, with the Topix Banks index gaining 4.7%. On Friday, it plunged 11%. Mitsubishi UFJ Financial Group Inc., the country’s biggest bank, plummeted 12% on Friday, despite reporting earnings that beat analyst expectations on Thursday. Likewise, Mizuho Financial Group Inc. declined 11% even after profit beat estimates. Daiwa Securities Group Inc. missed analyst estimates and suffered a 19% plunge in its share price. 

“It’s premature to say what’s going on today will lead to a lasting correction,” said Bloomberg Intelligence analyst Hideyasu Ban on Friday. “My impression is that a drop in overall market sentiment is dragging financial stocks lower, not that concerns over the potential worsening of fundamentals have emerged.” 

The shift in BoJ policy is also reverberating across global markets for everything from bonds to gold and Bitcoin. The yen has surged versus almost every major currency since the rate hike. That’s impacted speculative funds with big bets against the yen at one extreme, and at the other end of the scale, retail investors who borrow in yen and then use the money to purchase higher yielding currencies such as the Mexican peso. In the domestic corporate bond market, where issuance had been surging prior to the rate hike, higher rates will likely make investors more reluctant to hold long-maturity notes. 

Insurers and banks have been some of the top performers this year, with the sectors’ indexes outperforming the broader market. Earnings are forecast to improve as they start getting interest on their deposits with the central bank and raise mortgage rates for homeowners.   

“Higher rates will be supportive for financials — primarily banks but also insurance companies, we have an overweight position in financials,” said Daniel Hurley, a portfolio specialist for emerging market and Japanese equities at T. Rowe Price. “It’s the smaller and regional banks that should benefit the most – as the larger names have more foreign exposure and they will feel the impact of the yen strength weighing upon foreign returns.” 

Exporters have benefited the most from a weak yen and stand to lose the most from a reversal. The currency strengthened past 149 versus the dollar after the BoJ’s decision and the Fed signaling a rate cut. Additional rate hikes from the BoJ are likely to narrow the rate gap between the US and Japan. That in turn could further bolster the yen, which had fallen as low as 161.95 in early July. That’s made some investors less sanguine about the market’s prospects.

“Given the volatility in US tech stocks and the unwinding of carry trades in the foreign exchange market, we believe investors should prioritize this immediate risk,” said Sandeep Jadwani, head of investment advisory at Habib Investment Ltd. in the United Arab Emirates. “Japanese equities are likely to face continued downward pressure.”

Still, Rina Oshimo, a senior strategist at Okasan Securities Co., says yen assumptions by many companies are still stronger than current levels, so earnings are unlikely to significantly deteriorate.

“For companies with strong earning potential, a drop in their stock price might actually present a buying opportunity mid- to long-term,” she said.

Toyota Motor Corp. fell 4% on Friday after tumbling 8% the day before. Likewise, Honda Motor Co. sank 3.4%. The decline of some of the country’s most prominent companies raised speculation that the selling is coming from overseas. Last week, foreign investors started to cut their holdings. Once the main drivers of the market’s ascent, overseas investors sold net ¥1.56 trillion ($10.5 billion) Japanese cash equities and futures combined in the week that ended July 26, according to data from Japan Exchange Group Inc. 

“The selloff coincides with the carry trade starting to reverse,” said Frank Benzimra, head of Asia equity strategy at Societe Generale wrote in a note. “Which seems to indicate that flows, more than fundamentals are driving the market selloff.”

In contrast to the big manufacturers, Japan’s trading houses such as Marubeni Corp. have said that the central bank’s decision to raise interest rates is positive for their domestic businesses because it signals improvement in the economy. BoJ Governor Kazuo Ueda said during the press conference that while personal consumption “isn’t terribly strong,” it is still solid.

“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. “At the same time, Japanese equities cannot be isolated from global development, so we might also need to see relief of investors’ US recession concerns, and see moderation of yen strengthening - therefore we remain cautious in the near-term.” 

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