Nomura's Gu Chaoming: The reasons behind the global stock market crash

In early August, global stock markets experienced a significant decline, with the Japanese stock market suffering the largest drop. Nomura Securities' chief economist, Gu Chaoming, recently published a research report stating that the collapse of the Japanese stock market this time may be mainly due to investors' misjudgment of the Bank of Japan's monetary policy path. Investors may still be holding onto the belief that "the yen will continue to maintain an ultra-loose policy," but when they see the Bank of Japan's resolute determination to raise interest rates, coupled with signs of a slowdown in the U.S. economy, many investors choose to exit. Gu Chaoming believes that while the paradigm of the yen weakening leading to a rise in Japanese stocks was reasonable 30 years ago, the two have become increasingly unrelated in the current situation.

Investors may think it rose too fast

Gu Chaoming believes that one of the reasons for the significant pullback in global stock markets is that many market participants believe that stocks have risen too quickly. A sharp drop in stock prices or most other asset prices requires many investors to question the rationality of asset prices. When this happens and unexpected events occur, everyone rushes to exit the market, leading to a collapse in asset prices.

He believes that poor U.S. employment data and interest rate factors are not the triggers for the sharp drop in stock prices, as the Federal Reserve has maintained high interest rates for 16 consecutive months, yet U.S. stocks have continued to rise steadily. Gu Chaoming said that the massive liquidity provided by quantitative easing (QE) has weakened the impact of monetary tightening, making the financial environment more accommodative than the level of interest rates would suggest. He suspects that some institutions have been buying bonds, thereby helping to suppress the rise in yields, which in turn has driven stock prices higher.

Despite the U.S. inflation rate reaching 9.1% in June 2022, the yield on 10-year Treasury bonds has never significantly exceeded 5%. In fact, despite the high inflation rate, once there are expectations of a rate cut, yields will plummet sharply. Gu Chaoming said that this has weakened the impact of the Federal Reserve's tightening efforts, prompting senior Fed officials to make statements to suppress expectations of rate cuts, which in turn has led to an increase in the yield on 10-year Treasury bonds, and this process repeats itself.

Gu Chaoming analyzes that in this background, stock prices have been steadily rising, but he suspects that many market participants are questioning the wisdom of continuing to buy stocks at such high policy rates: it is very likely that these investors, once they see signs of a slowdown in the U.S. economy and hear the Bank of Japan talk about normalizing monetary policy, they will choose to exit the market one after another.

Misjudgment of Japanese Monetary Policy Path

The Japanese stock market experienced the largest decline among global stock markets. Gu Chaoming believes that one reason may be that before the adjustment, the Japanese stock market also experienced the largest increase. Many experts also believe that Bank of Japan Governor Haruhiko Kuroda's rate hike in July and his comments at a regular press conference led to a sharp appreciation of the yen and a sharp pullback in stock prices.

However, this rate hike was only 15 basis points. Normally, such a small rate hike would not trigger a stock market crash or a nearly 15-yen fluctuation in the USD/JPY exchange rate. This indicates that many foreign exchange market participants expected the Bank of Japan's ultra-loose monetary policy to continue, which surprised him.

Gu Chaoming analyzes that when loose monetary policy lasts longer than necessary, market participants become accustomed to this stimulus and eventually become dependent on it. In Japan, this situation is particularly evident as ultra-loose monetary policy has been in place for 11 years. He suspects that the recent sharp fluctuations in the yen and stock market are due to Kuroda's remarks pointing towards the normalization of monetary policy, causing these individuals to rush to exit the market

The View that a Weakening Yen Will Lead to Stock Price Increases is Outdated

Gu Chaoming believes that while the paradigm of a weakening yen leading to a strong Japanese stock market was reasonable 30 years ago, it has become increasingly irrelevant in today's circumstances.

He stated that 30 years ago, Japan's export industry, amidst numerous import barriers, created the world's largest trade surplus, leading to severe trade frictions with the United States. In this scenario, a weaker currency boosted export growth and economic expansion, with relatively minor negative impacts on consumers and producers due to their low dependence on imports. Therefore, Japan was able to gain significant net benefits from a weaker currency.

However, today, with Japan relying more on imports, a weak currency implies higher costs.

Today, Japan has opened its markets to the world, with ordinary consumers significantly more dependent on imports. Additionally, domestic industries have become much more reliant on imports, not only for raw materials but also for intermediate and finished products. Japanese companies also manufacture more products overseas.

Therefore, a weaker currency means many Japanese companies will face higher costs. Some companies have even stopped taking orders because the depreciation of the yen has led to increased costs of raw materials and intermediate products, making profits less lucrative. Over the past 30 years, there has been significant liberalization in food imports. While this has made Japanese consumers' diets more diverse, it also means that a weaker currency will directly impact their wallets.

Therefore, Gu Chaoming believes that if investors still base their decisions on the viewpoint from 30 years ago, that a weakening yen is beneficial for Japan and buy Japanese stocks, despite all the structural changes that have occurred since then, there is a significant misunderstanding.

Furthermore, he believes that many foreign investors' views on Japan have not changed in 30 years, with many surprised that a weakening yen no longer necessarily benefits the Japanese economy or leads to a reduction in domestic demand, unable to imagine that the Bank of Japan would take proactive measures to support the yen. Gu Chaoming suspects that the determination of the Japanese government and the Bank of Japan to prevent the yen from sliding has shocked these investors, leading to panic selling.