Global Investors Turn Bearish on Japanese Stocks Amid Market Turbulence

Global investors are becoming bearish on Japanese stocks after recent market volatility. The once-popular yen-funded trades are now under scrutiny due to the Bank of Japan's interest rate hikes, doubts around earnings, and U.S. economic slowdown. Hedge funds and long-term investors are exiting positions, while analysts warn of continued uncertainty.

Global investors are turning bearish on previously favored Japanese stocks following last week's turbulence, prompting a reassessment of economic prospects and the viability of yen-funded trades.

Once a hot trade, using the cheap yen to buy stocks on the Nikkei index has become less attractive due to sudden volatility in the Japanese yen, Bank of Japan (BOJ) rate hikes, doubts surrounding Japan Inc.'s earnings, and concerns over a stalling U.S. economy.

Trading volume for the CSOP Nikkei 225 Daily Double Inverse exchange-traded fund, the only ETF outside Japan allowing bearish bets against the Nikkei index, surged dramatically during the week ending Aug. 9. The average daily turnover for the Hong Kong-listed product hit nearly HK$20 million ($2.57 million), a 20-fold increase from the previous week's roughly HK$1 million per day, marking the highest since its launch in May this year.

Global hedge funds exited Japanese equities at the fastest pace in over five years between Aug. 2 and Aug. 8, according to Goldman Sachs, prompting long-term investors to begin reducing exposure as well.

Ben Bennett, head of investment strategy for Asia at LGIM, noted that the BOJ's quantitative tightening and a strong yen pose significant headwinds for Japanese stocks. LGIM's multi-asset funds had already turned underweight on Japanese equities prior to last week's market volatility and maintained that stance afterward.

On Monday, Japanese stocks faced their worst one-day sell-off since 1987, driven by fears of a U.S. recession and a surprise rate hike by the BOJ. This led to a massive unwinding of billions of dollars from the popular yen carry trade, which had financed the purchase of risk assets, including Japanese equities. Analysts caution that while the full impact of this unwinding remains uncertain, factors such as yen appreciation and a spike in the CBOE Volatility Index suggest it may continue.

The yen surged from around 162 per dollar in mid-July to approximately 142 per dollar last Monday, its strongest level in seven months. 'One of the drivers of upside in Japanese equities is going to phase out,' said Carlos Casanova, senior economist for Asia at Swiss asset manager UBP, referring to yen carry trades.

'Now we need to see an improvement in fundamentals, such as upward revisions in earnings,' he added. 'And that won't happen unless there's a recovery in the domestic economy.' UBP has recently reduced its positions in Japanese equities and now holds a neutral view.

Zuhair Khan, a Tokyo-based senior portfolio manager at UBP, stated that trading the Japanese market has become increasingly difficult due to unpredictabilities in the U.S. interest rate cut path and the yen. Markets are awaiting data on Japanese second-quarter economic growth and U.S. inflation due this week. 'No one wants to act rashly now,' said Steven Leung, executive director at UOB-Kay Hian in Hong Kong. 'Investors need to wait for crucial figures this week to make a more informed decision about whether the selloff in Japanese stocks is over.' ($1 = 7.7882 Hong Kong dollars)