(Bloomberg) — The rally in Japanese stocks has pushed some market indicators close to levels struck ahead of last year’s meltdown, after a US trade deal propelled equities to a record.
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“When the market starts rising this quickly, I do think we need to be cautious with what happened in August in mind,” said Hisashi Arakawa, director and the head of equities at abrdn Japan Ltd. “This time around, it’s not the yen driving the rally but I’m definitely keeping a close eye on the levels we saw during last summer.”
Japanese stocks crashed last August in the wake of the Bank of Japan’s (8301.T) unexpected interest rate hike, coupled with Governor Kazuo Ueda’s hawkish messaging and economic concerns in the US. The central bank has since managed to raise its policy rate without triggering a repeat of that rout, and the macro environment has shifted, with US tariff policies the main driver of the market.
Still, some technical indicators show Japanese equities are now looking vulnerable like they did just before last year’s selloff, when the Topix index was trading at record highs.
The Topix’s 14-day relative-strength-index was about 79 on Thursday, above the threshold that signals the market may be in overbought territory. The benchmark was in that range last July, less than a month before the selloff.
The Topix index traded more than 5% above its 25-day moving average on Thursday, a level has traditionally preceded a correction, according to Rakuten Securities Inc. Recently in September 2021 and March 2022, the divergence above 5% was followed by a market downturn.
The rally in the Topix index hasn’t been accompanied by rising turnover, similar to last July’s pattern, suggesting there may be a lack of conviction in the market.
The market might face volatility after its rapid gains as we head into the “summer lull” period in August when the trading volume shrinks, said Rieko Otsuka, a strategist at MCP Asset Management Japan.
As Japan enters peak earnings season, some companies may maintain a cautious outlook as they gauge the impact of tariffs, said Otsuka adding that stocks valuation will need to be justified by earnings. The Topix index’s forward price-to-earnings ratio is now close to the levels just before last August’s decline, at 15.7 times versus 15.87 last July, but still cheap in comparison to the US.