Japan’s stock market could face a rocky Q1 in 2024

The Federal Reserve’s surprise guidance for looser monetary policy sometime next year seemed partly intended for the US central bank to regain some control of the narrative as the market had already sensed the peak in rates since early November and had begun anticipating a policy pivot to more dovish posture in the face of falling inflation rate. As we noted last week with yen continuing to regain some of this year’s big losses and the ten-year JGB yielding no more than 70bps, two major factors that had BOJ on the hook to abandon its “lower for longer” policy have evaporated for now. Moreover, we continue to strongly believe that much of Japan’s manufacturing sector is facing a recession that will likely keep BOJ standing pat in next week’s policy board meeting. 

The above developments have also had a notable impact on sectoral performances of Japan’s equity market with banks and insurance firms starting to underperform while major exporters, namely autos have also been coming under selling pressure. The only notable recent outperformers have been semiconductor-related names which had been among the big market winners in 2023 already, leaving them further stretched as the market has more or less ignored geopolitical disruption risks that may include further tightening of export restrictions to China which now accounts for nearly half of revenues of major chip manufacturing equipment makers in Japan. 

As we have also previously noted, investors seem to have also chosen to overlook the strong possibility that this hoarding of equipment and devices which have greatly front-loaded China’s expansion plans, could become exhausted sometime next year, providing a huge drag on revenues just as the investment cycle outside of China seems to have bottomed out. Indeed, we have become particularly concerned about the likelihood of a major chip oversupply in legacy nodes, not only because of Chinese capacities coming on line but also elsewhere in US, Europe and Japan, encouraged by heavy government grants that have all the hallmarks of creating white elephants such as Japan’s Rapidus. 

Another significant development in Japan is the political fallout from alleged slush funds which have engulfed MPs of some key factions within the ruling LDP party. As we noted last week, this could not only spell the end of Mr Kishida’s reign as Japan’s PM by April next year, but more interestingly is also threatening to break up the party as the latest reshuffle of Kishida’s cabinet have bypassed some key interest groups. Although such political upheaval is generally viewed negatively, we think it could push forward some popular reformists such as Mr Taro Kono and Mr Shinjiro Koizumi to the front line of the political establishment that could provide a positive catalyst for the market if does happen. Come what may, there are some major uncertainties both economic and political facing Japan’s stock market in the near term that keep us generally cautious going into Q1 of 2024.