Japan’s stock market plunges to 8-month low after BOJ rate hike: What’s next for investors?

Japan’s stock market plunged to an eight-month low on Friday, following the Bank of Japan’s (BOJ) decision to raise benchmark interest rates to their highest level since 2008. 

This decline, spanning two consecutive days, has rattled investors and analysts, leading to significant market volatility.

The Nikkei 225 fell 5.81% to close at 35,909.7, marking its worst day since March 2020 and dropping below the 36,000 mark for the first time since January. 

Meanwhile, the broader Topix index experienced an even larger loss of 6.14%, closing at 2,537.6, marking its worst day in eight years.

Nikkei 225’s worst day since March 2020

This sharp decline contrasts starkly with Nikkei’s performance less than a month ago when it hit an all-time closing high of 42,224.02 on July 11. 

The sudden downturn has sparked discussions among analysts about the future trajectory of Japan’s markets. Bruce Kirk, Chief Japan Equity Strategist at Goldman Sachs, described the situation as a “transitional phase” during an interview with CNBC.

The recent rally in Japan’s stock markets had been driven by three primary factors: yen weakness benefiting blue-chip exporters and banks, expectations of monetary policy normalization, and corporate governance reform. 

However, the BOJ’s recent rate hike has altered these dynamics. 

“The rules of the game have definitely changed, particularly around rates and FX,” Kirk noted. 

Investors are now reassessing their sector positioning in light of the new economic environment.

Shift to domestic demand-focused stocks

Despite the sharp declines, there is a silver lining in this repositioning. 

Investor interest in Japan’s small- and mid-cap companies is on the rise for the first time in about three years. 

These companies, with higher exposure to domestic demand and reduced vulnerability to foreign exchange fluctuations, are becoming more attractive to investors. 

Kirk highlighted that “people are now looking for areas that are more domestic demand-focused, and that’s really putting the interest back on Japan’s small and mid-caps.”

Kirk outlined two possible reasons behind the current reassessment following the BOJ’s rate hike. 

First, there is skepticism among investors about the Japanese economy’s ability to handle a 25 or 50 basis points policy rate hike. 

Second, there are concerns about the profitability of Japanese corporations with the yen trading below 150 against the dollar. As of now, the yen trades at 149.4 against the greenback, having dipped below the 150 level since the BOJ decision on Wednesday.

Japan’s markets were Asia’s top performers last year and remained strong until June this year. 

The recent downturn marks a significant shift, but analysts like Kirk believe the market’s rally story is not entirely broken. 

Instead, the narrative is evolving, and this evolution is likely to be accompanied by continued volatility and aggressive sector rotation. 

The reassessment by investors indicates a search for new opportunities in a changing economic landscape.

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