Bank of America said Japanese equities may be stabilizing after a rapid rise in market turbulence sparked by the Middle East crisis, but stressed that the outlook remains uncertain while oil prices stay high.
The bank highlighted that the Nikkei Volatility Index climbed above 50, a threshold BofA associates with potential market bottoms. The trend and magnitude of the rise, the bank noted, resemble the pattern seen around last April's so-called "Liberation Day," when investors initially underestimated the severity of risk before quickly repricing and the market began to recover as clarity improved.
BofA attributed the recent sell-off in Japanese stocks to two main dynamics. First, Japan's economy is non-resource intensive, leaving it particularly sensitive to higher energy costs. Second, investors were forced into position adjustments, which, together with the spike in oil prices, tightened financial conditions swiftly and led to sharp falls in some popular names.
The bank singled out divergence across sectors. Shares linked to areas such as AI and defense experienced significant declines amid the shock, while IT services and other IT-related names that had lagged previously produced positive returns during the episode.
BofA also pointed to mechanical factors that amplified volatility. Pension funds and financial institutions engaged in selling ahead of the fiscal year-end, driving pressure on markets at a time when the setup was particularly susceptible to reversal. That combination of forced flows and timing, the bank said, accentuated moves that might otherwise have been more muted.
Looking ahead, BofA expects a gradual recovery in stocks beginning around April, though it cautioned that it is premature to be definitive. The bank did not rule out a prolonged Iran-Israel conflict as a risk, but emphasized that market trajectories will hinge importantly on the extent of U.S. aggression and involvement. If those elements subside, the bank suggested there could be scope for concessions and a subsequent easing of market sensitivity to events in the Middle East.
BofA also discussed the political and economic backdrop affecting oil price dynamics. It observed that sustained high crude prices would be undesirable for President Trump and the Republican Party in a mid-term election year, and noted the planned end-March trip to China as a contextual point that could influence risk perceptions. The bank said these factors might contribute to a gradual reduction in threats from around April, although it stopped short of asserting this outcome.
The bank warned that if crude oil remains above $100 per barrel, a variety of risks would likely surface. Under such a scenario, BofA argued, higher-quality and defensive equities - those with limited exposure to macroeconomic headwinds - would probably outperform. Conversely, if the oil-driven spike proves short-lived, the high-beta and momentum-driven stocks that sold off during the volatility burst are more likely to recover, even as short-term stock selection remains mixed.
Summary - BofA sees indicators that Japanese equities may have hit a bottom after a volatility spike linked to the Middle East crisis, but stressed that elevated oil prices and uncertain U.S. involvement keep risks elevated. Recovery is viewed as gradual and conditional.
Key points
- The Nikkei Volatility Index surged above 50, a level BofA associates with potential market troughs.
- Sell-offs were driven by Japan's non-resource profile, rising oil prices, and forced selling by pension funds and financial institutions ahead of fiscal year-end.
- Sectors affected include AI and defense (declines), and IT services and IT names (relative outperformance).
Risks and uncertainties
- Prolonged Iran-Israel conflict remains a material risk for markets, with particular implications for energy and broadly for investor risk sentiment.
- Persistent crude prices above $100 would elevate macroeconomic pressures and likely favor quality and defensive stocks over cyclical or high-beta names.