Japan $314 Billion Rout Tests Topix Bulls Who Pushed Gain

Photographer: Junko Kimura/Bloomberg

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Photographer: Junko Kimura/Bloomberg

Employees work on the trading floor of the Tokyo Stock Exchange in Tokyo.

The biggest drop in Japanese shares since the 2011 earthquake erased $314 billion in market value, shaking bulls who pushed the Topix Index to five-year highs and highlighting their vulnerability to shocks at home and abroad.

This year’s best performing major equity gauge plunged 6.9 percent in record volume yesterday after government bond yields rose to the highest levels in a year and Chinese manufacturing missed estimates. The slide triggered a halt in Osaka-traded index futures and cut the measure’s 2013 advance to 38 percent from 48 percent. Gains for the Topix, which rose 0.5 percent today with an intraday range of 6.5 percentage points, remain more than twice as big as in the Standard & Poor’s 500 Index (TPX) this year.

JPMorgan Asset Management and Pinebridge Investments LLC said the selloff was overdue after $1.2 trillion was added to equities on speculation Prime Minister Shinzo Abe and the Bank of Japan would end two decades of deflation. The Topix traded at as much as 24.8 times earnings this week, higher than 86 percent of days since 2004, data compiled by Bloomberg show. Mark Matthews, who helps oversee $282 billion as head of Asia research at Bank Julius Baer & Co., said the rally will resume.

“There was a lot of froth in the market,” Matthews said in a phone interview from Singapore. “Fundamentally, this remains a compelling investment, and in hindsight, this will be a buying opportunity. The bull market won’t end so quickly.”

Global equities slid for a second day yesterday amid concerns four years of unprecedented central bank stimulus will be curtailed. The U.S. Federal Reserve could “step down” the pace of asset purchases in the next few meetings if the labor market continues to improve, Chairman Ben S. Bernanke told Congress on May 22.

Today’s Trading

The MSCI All-Country World Index was little changed after closing 1.4 percent lower in New York, while futures on the Standard & Poor’s 500 Index added 0.1 percent. The Nikkei 225 Stock Average swung through more than 7 percentage points today before closing 0.9 percent higher.

The Topix today briefly climbed back above the 1,200 level it breached for the first time in almost five years on May 10. The gauge swung wildly as the yen gained after BOJ Governor Haruhiko Kuroda said stimulus efforts are sufficient.

Shares changing hands and the value of equities traded on the first section of the Tokyo Stock Exchange reached records yesterday. It was the first time since April 2005 that every company on the Nikkei 225 declined. About 96 percent of the 1,709 companies on the Topix advanced this year through May 22, with 97 firms, including Tokyo Electric Power Co. (9501), Mazda Motor Corp. and Sony Corp., more than doubling.

Speculation Increase

The selloff came amid signs of rising speculation in Japanese equities. Options prices on the Nikkei 225 Average (NKY) climbed unprecedented levels relative to American shares in the days before the selloff. Implied volatility surged more than 80 percent to 25.15 as of May 20, almost twice as high as in the Standard & Poor’s 500 Index.

Most of the increase reflected traders betting the advance would continue. Among the 10 most-owned options on the iShares MSCI Japan Index Fund (EWJ), which trades in the U.S., eight were bullish on May 20. June and September $12 calls had the largest open interest that day, data compiled by Bloomberg show. The fund fell 6 percent to $11.40 in New York.

The Nikkei Volatility Index jumped 58 percent to 43.74 yesterday, the biggest advance since March 2011, according to data compiled by Bloomberg. Fifty-day volatility for the Topix climbed to 28.83, the highest since May 2011, the data showed.

‘Too Much’

Speculative bets by the largest investors on the Nikkei 225 have slipped for three weeks after reaching a record in April. Net long positions among so-called non-commercial traders fell by 660 contracts to 13,781 in the week ended May 14, according to Chicago Mercantile Exchange data compiled by the Commodity Futures Trading Commission. The level reached an all-time high of 16,868 in the week ended April 23.

Japanese equities had risen “too much, too fast,” especially financial stocks, former Ministry of Finance official Eisuke Sakakibara, known as “Mr. Yen” for his efforts to influence exchange rates in the late 1990s, said in a Bloomberg interview on May 15. Shares needed “some kind of correction” before resuming their climb, he said. Banks, brokerages, consumer lenders and real estate companies led declines among the Topix’s 33 industries yesterday.

The yen strengthened as much as 0.9 percent to 101.09 per dollar in Tokyo after climbing as much as 2.3 percent yesterday, the most since Feb. 25. Gains in Japan shares have coincided with a retreat in the currency as traders speculated exports would increase.

Amari Assurance

“There’s no need to be perturbed as the Japanese economy is recovering soundly,” Akira Amari, Japan’s economy minister, told reporters in Tokyo yesterday as the Nikkei 225 Stock Average lost 7.3 percent. “We will continue to calmly proceed with pragmatic policies.”

An index of brokerages has recorded the biggest year-to-date increase on the Topix, climbing 79 percent through yesterday. Mining companies, the worst performing of the 33 groups, are still up 7 percent, data compiled by Bloomberg show.

Japanese equities have soared since elections were announced in November that brought Abe to power on a platform of massive economic stimulus. The Bank of Japan has pledged to attain 2 percent inflation within two years with unlimited bond buying and by doubling the monetary base.

Yields on benchmark 10-year notes hit 1 percent yesterday for the first time since April 2012, tripling from the record low reached last month after the BOJ announced unprecedented bond buying. The central bank announced a 2 trillion yen ($19.6 billion) injection of one-year funds to financial markets that an official who asked not to be named due to the bank’s policy said was aimed at curbing volatility.

BOJ ‘Overwhelmed’

Selling from JGB investors has “overwhelmed the BOJ’s ability to purchase them,” J. Kyle Bass, who has predicted a financial collapse in Japan since 2010, wrote in an e-mailed response to questions. His Hayman Advisors LP made $500 million amid the U.S. subprime crisis. “The BOJ is going to have to dramatically expand its JGB purchasing operation if it is going to be successful in holding back rates.”

Yesterday’s stock plunge may be the beginning of a longer slide as individual investors face calls to cover losses in stocks they bought with borrowed money, said Prospect Asset Management Chief Investment Officer Curtis Freeze, who helps manage about $340 million in assets.

The value of shares being purchased through margin-trading accounts surged to the highest since 2008 as of May 17, according to data compiled by Bloomberg. Private investors accounted for 27 percent of the value traded in the first section of the Tokyo Stock Exchange in April, up from 15 percent in October, according to data from Japan Exchange Group Inc.

Margin Calls

“We’ll be in for a few weeks of a shakeout as people are forced to sell things to raise cash for their margin calls,” Freeze said in a phone interview. “My guess is it’ll bottom in August. It’s back to reality. Share prices had nothing to do with reality at the company level.”

Even with the drop, the Topix remains the best performing benchmark equity index in local currency terms among the 24 developed markets tracked by Bloomberg. It has risen 18 percent in U.S. dollars, 0.6 percentage point less than the S&P 500.

A global poll by Bloomberg released May 17 showed investors are more confident in a Japanese leader than any time since at least September 2010, with optimism about Abe’s policies exceeding that for counterparts in the U.S. and Europe. The number of respondents who were more optimistic than pessimistic on the impact of Abe’s plans on Japan’s investment climate rose to 66 percent from 54 percent in January, the survey of analysts and traders who are Bloomberg subscribers showed.

Private Investment

The government said last week that gross domestic product rose 3.5 percent at an annualized pace, the most in a year, propelled by consumer spending and export gains. At the same time, the report underscored the need for steps to revive domestic business opportunities, with the fifth straight quarterly drop in private, non-residential investment dragging on growth in the first quarter.

Earnings on the Topix are forecast to expand about 33 percent this year, according to data compiled by Bloomberg. About 60 percent of companies that have reported full-year earnings since April 1 for which Bloomberg has analyst estimates exceeded projections, the data show. Profit in the S&P 500 are projected to grow 10 percent this year.

Short Term

“Everyone is surprised at today’s drop, but it was overdue,” said Grace Tam, Hong Kong-based global market strategist at JPMorgan Asset Management Ltd., which oversees about $1.5 trillion globally and increased holdings of Japanese shares yesterday. “Many investors looking for an opportunity to buy can find a good entry point now. It’s a short-term correction.”

Japan’s broadest benchmark index traded 14 percent above its 50-day moving average on May 22. Its 14-day Relative Strength Index was at 77.8, having spent nine days above the 70 level that some investors use as a sign the measure is overbought. It fell to 50 yesterday.

The Topix index opened yesterday little changed before a decline was extended with the release of China data showing manufacturing unexpectedly contracted, raising concern about the strength of the world’s second-biggest economy. The Nikkei 225 advanced as much as 2 percent before plunging as trading resumed after the midday break.

“The market has been looking for an excuse for a correction,” said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors Ltd., which oversees $126 billion. “Technically, Japanese shares have been overbought and were vulnerable for a correction.”

Less Selling

China’s manufacturing report spurred less selling in other Asian markets yesterday. Hong Kong’s Hang Seng dropped 2.5 percent, Australia’s S&P/ASX 200 decreased 2 percent, and Korea’s Kospi lost 1.2 percent. The Shanghai Composite Index fell 1.2 percent.

Futures trading in Osaka was halted at 14,780 yen at 2:28 p.m. in Tokyo yesterday as circuit-breakers were triggered, Yoshifumi Hanatani, an official at the Osaka Exchange, said by phone. It is the first time trading of the contracts have been halted since March 15, 2011, in the immediate aftermath of Japan’s earthquake, tsunami and nuclear disaster.

“This plunge is just so overwhelming,” said Tatsushi Maeno, head of investment at PineBridge Investment Japan Co., which manages about $11 billion globally. ‘There would be a risk that the markets have a big correction in the next couple of days. I still believe that this correction provides investors a great opportunity to buy Japanese shares.’’

To contact the reporters on this story: Anna Kitanaka in Tokyo at akitanaka@bloomberg.net; Jason Clenfield in Tokyo at jclenfield@bloomberg.net

To contact the editor responsible for this story: Nick Gentle at ngentle2@bloomberg.net

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