Bank of America Merrill Lynch believes that as long as a sharp rise in crude oil does not cause the Federal Reserve to raise interest rates, Japanese stocks may rebound.
On Friday, April 26, the yen/dollar exchange rate fell below 156 to a new low, the first time since June 1990.
Since this year, the “endless decline” of the yen has continued to support Japanese stocks, and the Nikkei 225 Index has accumulated a cumulative increase of nearly 14%.
Next, can the weakening yen continue to support the rise of Japanese stocks?
On April 23, Bank of America Merrill Lynch released the latest research report, which deduces three situations in the future trend of Japanese stocks. Among them, the Federal Reserve's interest rate path and crude oil trend will be important influencing factors.
The report points out that as long as crude oil does not soar and the Federal Reserve starts an intensive cycle of interest rate hikes, Japanese stocks may rebound.
Three possible future scenarios for Japanese stocks
The report suggests three situations that Japanese stocks may face:
First scenario: The US economy remains strong, but is being held back by high interest rates and a strong dollar. The Federal Reserve is expected to cut interest rates in December. If the risk of a sharp rise in crude oil prices subsides, the global financial environment may ease somewhat.
Second scenario: Higher crude oil prices led to a tightening of the financial environment (similar to the second half of 2023). If the data shows a rapid economic slowdown, it may pave the way for the Federal Reserve to cut interest rates.
The third situation: the price of crude oil soared, causing the Federal Reserve to start a second round of intensive interest rate hikes, and the overall risk increased.
According to the report, the first scenario is the main assumption; the second scenario may occur. As long as the third situation is avoided, Japanese stocks may rebound.
The report also added that in the first case, the crude oil premium is expected to remain between 5-10 US dollars/barrel. Once the conflict between Iraq and Israel escalates into an all-out war, the third situation will occur, causing the price of crude oil to be higher than 150 US dollars per barrel for a long time, but if the Federal Reserve can cut interest rates in July or September, then there will be a lot of room for a rebound in the market.
Generally, there is a positive correlation between earnings per share (EPS) and crude oil prices. Higher oil prices generally indicate that the global economy is recovering, which supports EPS, but if oil prices soar beyond expectations, this model will not be tested.
Looking specifically at stock types, Bank of America Merrill Lynch believes that value stocks will outperform the market, and defensive stocks with low volatility will also remain strong. If the US dollar stops rising, stocks facing domestic demand and late-cycle stocks in the manufacturing industry may rise.
The medium-term outlook for Japanese stocks has not changed
The report mentioned that although the valuation of the Japanese stock market has been adjusted, it has not yet been revised to a level that can be confirmed as the bottom.
At a stage where the global financial environment is slowing down and the risk tolerance of foreign investors is increasing, the price-earnings ratio of Japanese stocks tends to rise sharply. Conversely, when the financial environment deteriorates, the cog turns in the opposite direction.
Currently, the financial situation has deteriorated, and the overinflated price-earnings ratio is returning to a level consistent with profit.
According to the report, the medium-term outlook for the Japanese stock market has not changed, and the weakening of the yen caused by rising US interest rates will ultimately help Japan's inflation.
If the “spring fight” continues to be enforced next year, the virtuous wage and price cycle will become more stable. Furthermore, subsequent corporate governance is also expected to consolidate the rise in Japanese stocks.
Although the turbulence in the financial environment seems to have caused foreign investors to withdraw from the Japanese stock market one after another, there is still plenty of room for long-term capital to weigh on it.