Investors take long-term view as interest rate hike rocks Japan

This Japan’s interest rate hike last week hit the benchmark index the hardest in eight years. Despite the turmoil, some investors still believe in the country’s long-term stock prospects.

The Bank of Japan’s (BOJ) decision on Wednesday (July 31) to raise interest rates to 0.25 percent has sparked a wave of market volatility. The Topix index rose 1.5 percent on the day but fell sharply on Thursday and Friday.

The BOJ’s move, coupled with signals from the U.S. Federal Reserve that it will cut interest rates, boosted the yen. The weak currency has been a key factor supporting Japanese export stocks. However, as the country normalizes from years of negative interest rates, strength in corporate prices and higher wages for workers will spur growth that will support the market, according to investors and analysts at Hang Seng Investment Management, Goldman Sachs and T Rowe Price.

“Long-term fundamentals remain fair,” said Wilfred Sit, director and chief investment officer at Hang Seng Investment Management. “Looking to next year, the Japanese economy could show more signs of a gradual recovery.”

Financial stocks were hit the hardest. The sector surged after Wednesday’s interest rate hike, with the Topix Banks index gaining 4.7 percent. It fell 11 percent on Friday. Mitsubishi UFJ Financial Group, the country’s largest bank, fell 12 percent on Friday despite posting earnings that beat analysts’ expectations on Thursday. Similarly, Mizuho Financial fell 11 percent even after a profit topped estimates. Daiwa Securities missed analysts’ estimates and saw its stock fall 19 percent.

“It’s too early to say what’s happening today will lead to a lasting correction,” Bloomberg Intelligence analyst Hideyasu Ban said Friday. “I think it’s the decline in overall market sentiment that’s dragging financial stocks down, not concerns about potential deterioration in fundamentals.”

The BOJ’s policy shift is also reverberating across global markets, from bonds to gold to bitcoin. The yen has surged against almost every major currency since the rate hike. That has affected speculative funds that have bet against the yen on one hand, and retail investors who borrow in yen and then use the money to buy higher-yielding currencies like the Mexican peso on the other. In the domestic corporate bond market, where issuance was rising rapidly before the rate hike, higher interest rates are likely to make investors more reluctant to hold longer-dated bonds.

Insurers and banks have been among the best performers this year, with sector indexes outperforming the broader market. Profits are expected to improve as they start receiving interest on their central bank deposits and raise mortgage rates for homeowners.

“Higher interest rates will benefit the financial sector – banks in particular, but also insurance companies, we are overweight in the financial sector,” said Daniel Hurley, emerging markets and Japanese equities portfolio specialist at T Rowe Price. “It is the smaller and regional banks that should benefit the most – because the bigger names have larger foreign exposures and will feel the impact of the yen strength on foreign returns.”

Exporters have benefited the most from the weak yen and could lose the most from a reversal. The currency strengthened above 149 against the U.S. dollar after the BOJ’s decision and the Fed’s signaling of a rate cut. Additional rate hikes by the BOJ are likely to narrow the U.S.-Japan rate differential. That could further strengthen the yen, which fell to 161.95 in early July. That has made some investors less optimistic about the market’s outlook.

“Given the volatility in U.S. tech stocks and the move away from carry in the currency market, we believe investors should prioritize this immediate risk,” said Sandeep Jadwani, head of investment advisory at Habib Investment in the UAE. “Japanese stocks are likely to remain under downside pressure.”

Still, Rina Oshimo, senior strategist at Okasan Securities, says the yen assumptions for many companies are still stronger than current levels, so earnings are unlikely to deteriorate much.

“For companies with strong earnings potential, a decline in share prices can actually present a buying opportunity in the medium to long term,” she added.

Toyota Motor fell 4 percent on Friday after falling 8 percent the previous day. The decline in some of the country’s most prominent companies has raised speculation that the selling is coming from overseas. Foreign investors began trimming their holdings a week ago. Once the market’s main drivers, foreign investors sold a combined 1.56 trillion yen (14 billion Singapore dollars) of Japanese cash and futures shares in the week ending July 26, according to data from the Japan Exchange Group.

“The sell-off coincides with the beginning of a carry trade reversal,” Frank Benzimra, head of Asia equity strategy at Societe Generale, wrote in a note. “Which seems to indicate that flows, not fundamentals, are driving the market sell-off.”

In contrast to big manufacturers, Japanese trading houses such as Marubeni said the central bank’s decision to raise interest rates was good for their domestic businesses because it signaled an improvement in the economy. BOJ Governor Kazuo Ueda told a news conference that while personal consumption was “not particularly strong,” it was still solid.

“We continue to believe that improving domestic economic conditions are a key catalyst for growth in Japanese equities and remain constructive in the medium term,” said Kazunori Tatebe, a strategist at Goldman Sachs. “At the same time, Japanese equities cannot be isolated from global developments, so we may also need to see investors’ concerns about a U.S. recession ease and see the yen strengthen moderately — so we remain cautious in the near term.” BLOOMBERG