After the "circuit breaker for a sharp decline," will we see a "circuit breaker for a sharp rise"? Has the Japanese stock market hit bottom?

In the recent severe volatility in global markets, the Japanese stock market was hit the hardest, with the Nikkei 225 index plummeting 12% on Monday and rebounding over 10% on Tuesday, triggering multiple circuit breakers during the period.

Despite the "plunge and surge" causing significant impact on the market, analyses from JP Morgan and Citigroup suggest that the Japanese stock market may be nearing a bottom.

Japanese Stocks May Have Bottomed Out, Limited Impact from Yen Appreciation

Analysts Rie Nishihara and Yong Guo from JP Morgan released a report on Tuesday stating that since July 11, the TOPIX index has fallen by 24% and the Nikkei 225 index has dropped by 25%. This decline is not only influenced by the appreciation of the yen, but also reflects market concerns about the risk of a U.S. economic recession.

The two analysts believe that whether the Japanese stock market is oversold depends on the market's view of the risks of a U.S. recession and yen appreciation. Although the sensitivity of the yen to company EPS (earnings per share) has been decreasing since 2021, the recent rapid appreciation of the yen has only about a -8% impact on company fundamentals.

The market may further consider the impact of yen appreciation. However, even if the yen-to-dollar exchange rate rises to 140 yen, the impact on company fundamentals is limited to around -10%, which cannot fully explain the decline in stock prices. The report also points out that 60% of listed Japanese companies predict that the yen-to-dollar exchange rate for the fiscal year 2024 may be below 145 yen, with 20% predicting below 150.

In the most extreme scenario, 15% of the decline in Japanese stocks (=25%-10%) is attributed to the increase in stock risk premium due to the increased risk of a U.S. recession and heightened volatility.

JP Morgan stated that the market has already factored in the risk of a U.S. recession, and once the bottom is reached, a rebound is expected to focus on growth and quality stocks.

Citigroup's research view is similar to JP Morgan's. Analysts Ryota Sakagami, Keishi Ueda, and Rein Nukui stated in a report on Monday that the Japanese stock market has already priced in the slight U.S. recession and the yen rising to 140, therefore, there is limited downside for the stock market to continue falling.

By calculation, the three analysts concluded that even considering a slight U.S. recession, the bottom for the TOPIX index is around 2200 points, and for the Nikkei 225 index, the bottom is around 31000-32000 points, representing a decrease of about 9%-10% from current levels.

Citigroup believes that if the TOPIX index falls to 2200 points, its forward P/E ratio will drop below 12 times, which appears overly pessimistic even against the backdrop of yen appreciation Therefore, Citigroup Research believes that the Japanese stock market has reached the bottom area, with limited room for further decline.

Focus on US recession risks, Citigroup: Japanese stocks may trade flat in the near future, target price lowered

Although both institutions believe that Japanese stocks have bottomed out, their outlook for the future is more cautious.

JP Morgan emphasizes the need to continue monitoring the risk of a US recession, but also expects that funds buying on dips will support the relative performance of the Japanese stock market.

They believe that even if the US economy enters a recession, the decline in the Japanese stock market has already been comparable to that of US stocks, and considering the push for corporate reform and economic normalization, the Japanese stock market is expected to rebound.

Citigroup Research, on the other hand, points out that while the Japanese stock market may have already hit bottom, it is expected to trade flat in the near future, with the conditions for recovery not fully in place yet. These conditions include:

(1) Forming a consensus on a brief and mild US recession if it occurs;

(2) Forming a consensus that the global economy will be supported by the accommodative stance of the Federal Reserve and other major central banks;

(3) A weakening of the hawkish tone of the Bank of Japan.

In the short term, Citigroup expects risk aversion trades to dominate. Factors favorable to the Japanese stock market in a typical risk aversion phase include low beta values, low volatility, low leverage, high dividend yields, and stock buybacks.

Looking ahead, Citigroup believes that expectations for global economic recovery may trigger a stock market rebound. In this stage, growth, quality, and high-profit corrections should be effective.

Although Citigroup remains optimistic about the long-term prospects of the Japanese stock market, considering that it takes time for the market to bottom out after a significant adjustment, the institution has lowered the year-end target price for Japanese stocks, with the TOPIX target price lowered from 3000 points to 2900 points, and the Nikkei 225 index target price lowered from 43000 points to 41000 points, representing an increase of around 20% from current levels