As Japan Stocks Stage Comeback, Investors Doubt Rally Will Last

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(Bloomberg) -- Japanese stocks have roared back to life after a two-month selloff, but some investors and analysts aren’t convinced the good times will last for Asia’s best-performing equity market since late March.

“We’re not as bullish as we should be,” said Amir Anvarzadeh, a senior strategist at Asymmetric Advisors in Singapore. “We aren’t convinced that this is a recovery scenario.”

Anvarzadeh says he’s worried that the Bank of Japan will reduce its monetary stimulus earlier than expected. That, he says, will throttle the rally in the country’s stocks. Added to that are geopolitical concerns about Iran and North Korea, according to Mitsubishi UFJ Morgan Stanley Securities Co.

The Nikkei 225 Stock Average has jumped almost 9 percent since March 23 for one of the strongest returns of 94 primary equity indexes tracked by Bloomberg. It was a remarkable turnaround after a plunge starting late January that sent the country’s stocks into a correction. The rebound was fueled by the yen’s retreat from a 16-month high against the dollar as the two Koreas vowed to make peace and U.S. President Donald Trump said he’d meet North Korean leader Kim Jong Un.

Foreigners have been a major driving force behind Japanese stocks’ revival, turning net buyers in April after three months of net selling. Overseas investors purchased a net 207 billion yen ($1.9 billion) in cash equities last month, while also becoming net buyers of Topix index and Nikkei 225 futures.

To Anvarzadeh, continued rate increases by the U.S. Federal Reserve and inflationary pressures pose one of the biggest risks for Japanese equities. Rising market interest rates and higher input costs for companies, triggered by a jump in commodity prices, are bound to push the BOJ to cut back on its massive stimulus program, he said.

Some of the BOJ’s nine board members said it’s important to communicate thoroughly that the bank is still a long way from achieving the inflation target and isn’t at the stage of considering an exit, according to a record of comments from the March 8-9 policy meeting published this week. But one member said that while “normalization” could be considered at some point, the BOJ needs to explain to market participants that normalization would still be part of the process of monetary accommodation, and therefore different from tightening.

It’s interesting that BOJ board members “are already talking about that in the minutes," Anvarzadeh said. "The exit strategy of the BOJ will be much tougher than other central banks," he said. "The impact could be much bigger."

For Norihiro Fujito, a senior strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo, geopolitical developments relating to Iran are a more immediate concern.

Geopolitical Risks

Japanese stocks fell Wednesday after Trump said the U.S. will withdraw from the landmark 2015 accord to curb Iran’s nuclear program and reinstate financial sanctions on the Islamic Republic, opening an uncertain new chapter for the Middle East. His decision was intended to force Iran to renegotiate an agreement the country’s leaders have said they will not revisit. Trump’s political opponents warned he could lead the U.S. into another Middle-East war.

"There’s a possibility for things to get pretty tense," Fujito said. "This is something that warrants caution. Higher tension will push up the yen and stocks will be hit."

The timing of Trump’s move isn’t great for Japanese stocks as aggressive short covering by hedge funds will probably have run its course, Fujito said, leaving the market devoid of buying catalysts. Corporate earnings aren’t looking as stellar as they did last year, either, he said.

Some Optimism

Still, not everyone is buying the gloom.

“Japanese equities from a valuation perspective are cheap compared with markets like the U.S.,” said Mitsuo Shimizu, an equity strategist at Japan Asia Securities Co. in Tokyo. “Foreigners have been buying big since April. If corporate earnings are strong, of course they will keep buying.”

While it’s still early days in the quarterly reporting season, companies have so far mostly fallen short of analyst expectations. Of 246 stocks that have reported results this reporting season and for which Bloomberg has analyst estimates, 54 percent missed projections for profit.

And despite Shimizu’s optimism, Anvarzadeh and Fujito remain far from convinced.

"The rebound momentum in equities has weakened quite a bit," Fujito said. "If the U.S.-North Korea summit is devoid of details, the market response could be harsh."

©2018 Bloomberg L.P.

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