The Japan equity outlook after the market sell-off
The Japan equity market fell by over 20% in the first three days of August. The sell-off reached a crescendo on Monday, 5 August, with a 12% decline in one day¹. Edward Ritchie, Head of Japan Equities, explains the causes of the sell-off and provides our outlook for the equity market and the Bank of Japan (BoJ) rate path.
![](/content/dam/mim-institutional/region/asia/assets/images/outlook-after-japan-stocks-plunge-leading-market-sell-off.jpg)
- Fears of a US-led global recession
In our view, the main cause of the market rout was a sudden change in global investors’ expectations for a US-led global recession. This view was driven by some investors’ belief that the US Federal Reserve (Fed) had made a policy error by not cutting rates in late July – a perspective supported by weaker US employment and industrial-demand data. This change in opinion led to a large amount of de-risking. One of the most significant risk trades globally was the so-called ‘yen carry trade’, where global investors were shorting the yen and investing in the Japan equity market. The de-risking, or unwinding of this trade, has been the primary cause of the sharp strengthening of the yen and the decline of the Japan equity market.
- Japanese exporters’ profit outlook doomed by rate hike
Several other causes helped strengthen this sentiment change and exacerbate the sell-off. On 31 July, the Bank of Japan (BoJ) raised interest rates from 0-0.1% to 0.25%, which led to a strengthening yen². This policy move is expected to weaken the profit outlook for Japanese exporters. However, the impact of the yen on aggregate Japanese earnings is not as large as it has been historically.
Indeed, many Japanese manufacturers now produce from overseas. Hence, the currency effect tends to be more translational (translating overseas earnings back into yen) than transactional (selling Japan-produced products with a Japanese-yen cost base into overseas markets). Some commentators also see the risk of a domestic economic slowdown in Japan due to the interest rate increase, but, in our view, this is not a major risk.
- Global technology sell-off
Another cause was the change in sentiment towards global technology stocks that began earlier in July. The concern originated from comments by the current US administration that it would further tighten the rules on selling semiconductor equipment by the US and its allies to mainland China. Worries about the growth outlook for technology stocks increased when a leading technology company announced that it would cut 15% of its staff. This following a weak earnings announcement on 1 August, which revealed that quarterly profits had plunged by 85%.
Geopolitics remains an ongoing risk for investors as tensions appear to be rising again in the Middle East. However, we do not believe this has been a significant factor driving the rapid change in sentiment experienced in the early days of August.
Which sectors and factors have been hardest hit, and which have shown the greatest resilience?
The sell-off was fairly consistent across the board, with all sectors declining by over 10%³. The weakest sectors were financials (banks, insurance and brokers), followed by trading houses and autos. The best-performing sectors were mainly domestic and defensive segments, such as retail and healthcare, as well as railways and telecoms.
Despite the lack of yen exposure, financials were the hardest hit due to the market’s changing view regarding further rate hikes and the decline in 10-year bond yields (the 10-year Japanese government bond fell from over 1% to below 0.8%). In addition, the market began pricing in a 50% chance of a further 25 basis point rate hike by the Bank of Japan before the end of 2024 – by the end of July, this had fallen to an almost 0% chance. These moves changed investor sentiment towards financial stocks.
The better-performing sectors were domestic and generally defensive names. This gives us some confidence that the outlook for the domestic economy remains solid. Japanese consumers have been struggling with higher prices and have only recently seen real wage growth turn positive. The positive impact for domestic companies from lower import prices due to a stronger yen should help support Japan’s domestic economy companies.
In factor terms, growth and momentum companies have been hardest hit, while businesses with high-quality scores and high free cash flow yields have seen less severe share price declines.
Market outlook and investment implication
It is difficult to know how much further the ‘yen carry trade’ unwind may go and what impact this will have on the Japan equity market. However, based on previous sharp sell-offs, such as post-Fukushima disaster in March 2011 or the Covid-related sell-off in March 2020 (on both occasions, the market fell by 16-18% in less than a week and was followed by some recovery), such market declines can be short and sharp
The Japanese market is now trading on a very reasonable 12 times price-to-earnings(P/E) multiple, and companies have conservatively forecast flat earnings in 2024/25 based on an average yen/dollar exchange rate of 140. The US market is trading on a much higher 22 times P/E multiple⁴.
The Japanese market is also well supported by its dividend yield and a commitment by companies to share buybacks over the coming years. We estimate the combined shareholder returns for the Japanese equity market in 2024/25 will be over 5%.
Investors will continue to focus on high-quality companies with strong pricing power and efficient capital allocation. They will look for opportunities to add to some high-conviction names if significant upside emerges and stocks reach investors’ fair-value targets because of the market sell-off.
There is no change in our view that Japan is going through a period of transition from a deflationary to an inflationary environment and that companies with pricing power will be able to raise prices consistently. This will allow Japanese firms to grow their earnings and free cashflows more consistently and help drive a sustained rerating of the Japanese equity market.
Outlook for Bank of Japan’s rate path
Before the market sell-off, we believed that the BoJ would make one or two rate hikes in 2024 and some further rate rises in 2025 to bring interest rates towards normalisation. The BoJ has not been explicit on the ‘normalised’ interest rate level, but in our view, it should be higher than the current level of 0.25%.
The market no longer expects any further rate hikes in 2024. A further BoJ rate rise would be driven by the inflation rate remaining high (Japan’s Consumer Price Index currently stands at 2.8%). The recent yen strength may help keep a lid on higher inflation as import prices start to decline.
The unwinding of the ‘yen carry trade’ means that investors are no longer heavily geared to further sharp movements in the Japanese currency. This will remove a major concern for the BoJ and give it more freedom to act (i.e., take further action on raising rates) in the future without worries about the knock-on impact on financial markets.
1 Nikkei 225 Index. 2 Nikkei Asia, 31 July 2024: Bank of Japan raises interest rate to 0.25%, open to further hike this year - Nikkei Asia. 3 5 August 2024, Manulife Investment Management. 4 Based on one-year consensus forecast.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional
Australia: : Manulife Investment Management Timberland and Agriculture (Australasia) Pty Ltd, Manulife Investment Management (Hong Kong) Limited. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. Mainland China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area: Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority
United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Manulife Investment Management Timberland and Agriculture Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.
3787048