Japanese Investors Still Strongly Disposed to Yield and Value

Just before the most recent sell-off, investor confidence as measured by State Street, had just recovered to peak levels seen prior to the 2006 "growth scare" sell-off.

When markets are volatile and investors are skittish, opinions about the market cover the waterfront from bearish to bullish, which really is a reflection of increased uncertainty and growing risk aversion. In times such as these, the "fast money" first moves to reduce risk and take profits, which causes volatility to surge.

But the recent surge in stock market volatility, as measured by the VIX, peaked much lower than the peak in 2006. Moreover, it appears that the general downtrend in liquidity (and expansion of investor risk tolerance) remains in place, despite the 2007 and 2006 spikes.

Data compiled by the US CFTC shows a 56% contraction in the short positions in Japanese yen for large speculators between February 13, 2007 (when short positions hit a new record high) to a March 6, 2007 low. This was the source of a JPY6.83 reversal in the yen.

However, the capital flowing out of Japan last week to the tune of JPY 1,117.8 billion, compared to a JPY1,112.7 billion inflow in the week prior to the sell-off, helped to limit the yen’s sharp swing and means Japanese investors are still strongly disposed to buying higher yielding overseas assets, which will continue to exert downward pressure on the yen.

The sell-off took the Nikkei 225 to its 26-week moving average, where it has found support mainly because of strong rebounds in the steel, non-ferrous metals and utilities sectors. Given the relatively high correlation between the S&P Materials sector SPDR and the Nikkei 225, we expect basic materials to continue to lead Japanese stock prices for the foreseeable future, and especially individual value and higher yielding stocks, although the Nikkei 225’s recovery may be hampered by lingering yen carry trade unwinding fears.

This group includes such stocks as Fujifilm Holdings (FUJI) and Mitsui & Co. (MITSY), whose strong uptrends were only temporarily interrupted by the sell-off.

Disclosure: Author has no position in any of the above-mentioned securities.