Navigating volatility in the Nikkei225:Start of a Virtuous Cycle

10 de set.

By Danish Lim Zhi Lin, Investment Analyst

Current Performance of Nikkei 225 Index:
As of 9 September, the Nikkei 225 Index was down by -0.48%, after falling as much as 3% as weak US Payroll added to slowdown fears and dampened risk appetite. The Nikkei 225 Index saw a 5th straight decline, with data showing Japan’s Q2 GDP expanded less than expected at 2.9% QoQ, but still advancing enough to keep the BOJ on track to hike rates later this year. At the same time, China CPI and PPI data fell short of forecasts, adding to global growth headwinds that could weigh on Japanese equities.

With the upcoming US elections and Japan’s leadership race, the path ahead for the tech-focused Nikkei 225 Index is likely to see added volatility, even as investors countdown to the Fed’s rate first rate cut in 4 years.

“The Time Has Come”
“The time has come” was a memorable phrase from Chair Powell’s speech at the Jackson Hole Symposium. After several premature bets on Fed rate cuts earlier in the year, it appears that cuts are finally on their way. We expect discussion to shift towards the pace and reason behind Fed rate cuts.

In this backdrop, the Nikkei 225’s performance will largely depend on why rates are moving lower- with equities likely to outperform in a “soft landing”, but underperform in a “hard landing”.

With the US economy likely shifting from expansion into deceleration and a potential recession; and with previously-inflated valuations, a negative economic surprise such as last Friday’s payrolls data can trigger an outsized market reaction towards the downside. In other words, “Bad news will be Bad news” moving forward.

Green Shoots in Japan
However, fundamentals appear unchanged and we are inclined to believe that the recent bout of volatility is tied to weakness in the global economy rather than Japan itself. As mentioned in our previous post, we anticipated the August drawdown to be temporary as we viewed the increase in real wages, the first in 27 months, to be a key catalyst for the realization of a virtuous wage-price cycle that is expected to support consumer spending and boost sentiment. We also expect the BOJ to tread more cautiously regarding monetary policy moving forward, likely resulting in a more stable Yen.

At the same time, the government also presented its view that business investment is showing signs of picking up in its August monthly economic report, upgrading its monthly economic assessment for the first time in 15 months on signs of a consumption recovery.

Corporate reforms and growing shareholder activism have also led to higher dividends, more share buybacks and stronger balance sheets.

Other developments
Japan PM Fumio Kishida stepped down from his position and said he will not seek re-election on 14 August, paving the way for the ruling party to vote on his successor on September 27. A leadership vote in the ruling Liberal Democratic party set for Sept 27 will determine Kishida’s successor. Official campaigning for the LDP race starts on Sept 12, with about 10 candidates expected to run.

Geopolitical risks remain due to the upcoming US elections and potential chip curbs by foreign countries.

Nikkei 225 Outlook & Trading Opportunity:
In our view, we believe recent events have not altered the long-term fundamentals of the Japanese market. Nevertheless, volatility is to be expected with the upcoming US elections and global growth concerns lingering in the background; although we believe the overall trajectory for Japanese equities will be positive.

Alongside Fed rate cuts, a more moderate Yen could be beneficial for Japanese equities by lowering imported inflation and supporting consumer spending. In combination with wage hikes of around 5% expected in 2H, we expect real household income and private consumption to continue trending upwards, providing support to the Nikkei 225 despite a volatile backdrop.

In line with our view, we prefer to take entry on weakness, as we believe it provides an attractive entry point. Near-term volatility could see the Nikkei 225 Index under pressure; but we favour a long position in the long-run with a trailing stop-loss to help limit losses in the event of a sudden market downturn.

Expressing Our View:
We prefer the trade setup below to express our view:

Long Nikkei 225 Index Futures
Based on a Fibonacci Extension drawn from the October 2023 to the July 2024 high, the daily chart shows the index experiencing a brief rebound from the 5 August low of 31,156; but has since broken below the 0.382% extension level at around 37,000 – 37,100. We take this level as immediate resistance.

We expect to near-term volatility to bring the Nikkei 225 Index further down towards the 0.500% extension level around 35,697 – 35,700. We set this level as our entry point with a 5% trailing stop-loss, bringing our stop loss level to around 33,915. Our target level will be the 0.786% extension level around 40,499 – 40,500.

Several technical indicators support our view for near-term volatility:
- The MACD line is shown to have crossed below the signal line in a bearish crossover.
- Prices are below the 50-, 100-, and 200-day moving averages.

Alternatively, traders can consider a short position to take advantage of near-term volatility. But the risk-reward for a long position looks more promising, in our opinion.

We also favour an 5% trailing stop loss to pair with our long position, allowing us to lock in profits if the price moves favourably.

• Entry Level: 35,700
• Target Level: 40,500
• Stop Loss Level: 33,915 (trailing stop preferred)
• Profit at Target: 4800 x ¥500= ¥2,400,000
• Loss at Stop: 1785 x ¥500= ¥892,500
• Reward: Risk Ratio: 2.69x

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