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Markets

Japanese stocks teeter on edge of fresh turbulence

Upcoming earnings season will prove test of market's precarious balance

A woman struggles against strong winds caused by a typhoon in front of an electronic stock board in Tokyo. Japanese stocks, which have been stable for several weeks, may be in for a ride.   © Reuters

TOKYO -- The Nikkei Stock Average has seesawed in a narrow range for weeks, too cushioned by a global cash glut to fall, but too held back by the uncertain outlook to take off.

Crises like the coronavirus pandemic have often provided opportunities for buying Japanese blue chips. Yet foreign investors seem to be hesitating. A gauge of expectations of U.S. stock market turbulence may indicate why. 

The CBOE Volatility Index, or VIX -- sometimes referred to as the canary in the stock market coal mine -- shows that investors are still wary of shocks ahead. The index ended Tuesday at 29.43 -- a marked improvement from over 80 in mid-March, but still above the level of 20 considered normal.

For Japan, a key test of the stock market's stability lies in the coming weeks.

"The balance we are seeing now in this sluggish market, which is not too optimistic or pessimistic, is likely to collapse once the April-June earnings season picks up later this month," said Yunosuke Ikeda, chief equity strategist at Nomura Securities.

Ikeda notes discrepancies between top-down forecasts, which are derived from macroeconomic indicators, and bottom-up forecasts, which are based on analyst reports on individual companies. 

For example, earnings per share for the Tokyo Stock Exchange's broad Topix index is expected to drop 34% this year, according to top-down forecasts, but decrease just 6% according to bottom-up forecasts.

Analysts will be able to incorporate quarterly results into their models once they are released, and "bottom-up forecasts will probably be revised downward in line with the top-down forecasts," Ikeda said.

VIX futures offer further insights into investor sentiment. Usually, futures with longer expiration dates tend to trade for more, since it is harder to predict volatility in the more distant future. But October futures are currently the highest valued by far, with investors expecting turmoil in the stock market around the U.S. presidential election on Nov. 3.

This by itself is not new -- October futures have been priced higher since last year, before the coronavirus pandemic. Still, the entire futures curve has shifted upward compared with a month ago, with futures expiring from July to September now all showing index readings over 30.

There had been signs of a coming storm back in late January as well, when VIX futures for February spiked after China shut the city of Wuhan to stop the spread of the coronavirus. U.S. stock prices at the time saw little change, but later crashed.

Another crash of that magnitude seems unlikely. But the current equilibrium appears likely to end sooner than later now that the VIX "canary" has stopped singing.

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