Japanese equities tumble in February

The Japanese equity market tumbled in February, with the TOPIX (w/ dividends) falling 10.27% on-month and the Nikkei 225 (w/ dividends) dropping 8.82%. Japanese stocks initially rose at the start of the month as expectations that the Chinese government would bolster economic measures to mitigate the impact of COVID-19 (coronavirus) as well as news reports of treatments for the disease eased excessive economic slowdown concerns. However, from mid-month onward, the combination of weaker-than-expected Japanese GDP figures for the October-December quarter and the spread of COVID-19 outside of China amplified concerns that the virus could have a significant impact on the world economy. As a result, Japanese stocks ended the month sharply lower. All of the 33 Tokyo Stock Exchange sectors declined during the month, with Iron & Steel, Securities & Commodity Futures, and Land Transportation seeing the sharpest drops.

Exhibit 1: Major Indices (Last Month and Historic Changes)

Exhibit 1: Major Indices (Last Month and Historic Changes)

Source: Bloomberg, as of 28 February 2020

Exhibit 2: Nikkei 225

Exhibit 2: Nikkei 225

Source: Bloomberg, as of 28 February 2020

Assessing the deepening coronavirus impact

We are now gradually beginning to see how the spread of the coronavirus—which, not surprisingly, has impacted Japan due to its proximity to China— is affecting Japanese economic activity. Consumption has declined as the Japanese public has refrained from going out, shopping and travelling. And while we are yet to hear about sections of domestic production grinding to a complete halt, some companies with value chain exposure to China have been forced to curtail manufacturing. In short, uncertainty for investors has increased. But at the same time, the economy is not suffering an irreversible shock. The market’s immediate focus is whether the spread of the virus in Japan slows or accelerates in the coming weeks. Market sentiment is relatively sombre, and the likely consensus view is for the epidemic to linger until the summer.

In terms of market levels, the Nikkei Stock Average has basically reversed the gains previously made on US-China trade optimism. The market is not bottomless: it will eventually reach a level that is in line with the secular profit growth levels, in our view. We believe the stock market will eventually experience a steady recovery with the mid-year earnings season in October becoming a focal point. But in the short term, volatility is likely to remain high along with the deterioration in market sentiment.

The yen and global aggregate demand

The yen and the currency market have experienced sharp swings and much volatility generated by the coronavirus epidemic, which has forced investors to alter their views towards central banks, notably the Federal Reserve (Fed), and their monetary policies. Whether the yen appreciates or depreciates is usually an important topic as it has implications for Japanese exporters and their earnings. But we believe the situation is a little different this time. If the global economy as a whole is adversely affected by the virus epidemic, currency levels will not matter as much. We believe that rather than currency levels, the state of global aggregate demand will become a more important factor for the domestic exporting sector.

That said, the yen is still likely to remain a sensitive topic for the Bank of Japan (BOJ). There are views that the BOJ will stand pat while the Fed cuts rates and eases monetary policy, but assuming that it will do nothing would be a mistake. The central bank does have easing options including taking the policy rate deeper into negative territory. The Fed’s actions may overshadow those take by other central banks but we do have to remember that the BOJ is also capable of acting to address extreme moves by the yen.

Exhibit 3: Major Market Indices

TOPIX
TOPIX

JGB Yield
JGB Yield

USD/JPY
USD/JPY

Japan Equity Net Purchase from Overseas (JPY billions)
Japan Equity Net Purchase from Overseas (JPY billions)

Source: Bloomberg, as of 28 February 2020

Exhibit 4: Major Index Performance, Indicators, and Valuation

 Exhibit 4: Major Index Performance, Indicators, and Valuation

Source: Bloomberg, as of 28 February 2020
(e) stands for consensus estimates by Bloomberg.
Turnover and market cap in JPY trillions.
Net Purchase (JPY billions) from overseas is cumulative monthly.