Bank of America strategists say the intense price swings in Japanese stocks may be reaching an inflection point after a period of heavy selling. Their note highlights an abrupt rise in the Nikkei Volatility Index above 50 - a historically rare level - as evidence the market could be close to a trough.
Masashi Akutsu and Tetsuhiro Tokuyama, the strategists, wrote that the volatility spike “likely reflects something of an investor panic mindset, in our view, and is one signal of a potential market bottom.” They point to several interacting forces behind the sell-off and the sharp moves within market segments.
One major factor, the strategists said, was Japan's economic profile as a non-resource economy at a time when oil prices were rising. That backdrop, combined with changing investor positioning, contributed to the unwind of previously crowded trades. As oil climbed and financial conditions tightened, some positions that had been heavily held were reduced or liquidated.
The note details how stocks associated with themes such as AI and defense - which had rallied strongly earlier - suffered steep declines during the pullback. Conversely, certain IT services and other technology names that were earlier laggards posted positive returns despite the broader macro pressures. The strategists characterized these patterns as reflecting both underlying fundamentals and, “to a significant degree, position unwinding.”
Domestic flows within Japan also amplified market moves. The strategists said pension funds and other financial institutions likely sold equities ahead of the country's fiscal year-end. At the same time, rising bond yields provided a motive for some investors to realize equity gains in order to offset unrealized losses on fixed-income holdings, adding to selling pressure.
Despite the recent turbulence, BofA's team is cautiously constructive about a potential recovery. “The market is nearing a bottom and should begin recovering gradually from April, but it is still too early to be sure,” Akutsu and Tokuyama wrote, stressing that the outlook depends on external developments, notably the trajectory of oil and geopolitical tensions.
The strategists argue that the future direction of Japanese equities is closely tied to conditions in the Middle East and the consequent path for crude. If tensions between Iran and Israel ease and oil prices retreat, the sensitivity of the market to geopolitical risk could diminish and help stabilize equities.
However, they warned of a clear downside scenario: if oil prices remain elevated, particularly above $100, the consequences could be meaningful. “Oil prices remaining above $100 could weigh on corporate earnings, derail real-wage growth, and increase the likelihood of tighter financial conditions globally,” the note says.
Under that scenario, BofA expects that higher-quality and defensive companies, which are less exposed to macroeconomic headwinds, would outperform. By contrast, if the oil shock fades more quickly, the strategists see scope for high-beta and momentum stocks that were hit during the volatility spike to rebound.
For now, the team at Bank of America expects stock selection to remain mixed while market volatility stays elevated.