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Stocks

Tracking the dynamics of latest foreign flight from Japan stocks

TOKYO -- The sell-off of Japanese shares by overseas investors appears to be petering out, but the market is not out of the woods just yet.

     Net selling of equities and stock index futures by overseas investors reached a combined 2 trillion yen ($19.5 billion) in January, according to data released Thursday by the Tokyo Stock Exchange and the Osaka Securities Exchange. But one senior executive at a major brokerage says that selling by foreigners, blamed for the steep and sudden drop in domestic shares since the new year, is losing steam.

     Assessing whether the selling is truly nearing an end requires a look into the underlying reasons that triggered it in the first place.

     Many market players attribute the January sell-off to global hedge funds unwinding positions taken leading up to the year-end of going long on Nikkei stock index futures and short on the yen.

     For insight, industry observers cite Brevan Howard Asset Management, Europe's largest hedge fund with around $40 billion in investments that had the Japanese market abuzz at the end of last year with its long stock-index-futures and short yen positions.

     Co-founder Alan Howard has said little about his most recent moves in the Japanese market. But a manager at the fund notes Howard's extremely thorough risk management strategy and remarkable ability to act swiftly in the market. The manager goes on to say that once market volatility is determined to have exceeded the tolerance threshold, he will automatically square positions, so it is highly possible that he also started selling Japanese shares in the new year.

Short-lived selling?

This exemplifies the oft-cited "risk-off" strategy. Increasing volatility in the global markets, fueled by turmoil in emerging markets, may have compelled Howard to square the Japanese market positions. But this does not mean that he has walked away entirely from buying Japanese stocks or selling yen, as suggested by a letter to investors in early January.

     In the letter, Howard characterized last year's performance of the flagship fund, which eked out only a 2.59% return, as "somewhat disappointing." But he cited a windfall from betting in favor of Japan's Abenomics, or a so-called "Japan Trade" strategy involving stock buying and yen-selling. He added that the same theme remains valid for this year, saying that his team expects the government and Bank of Japan to pursue "further policy actions" to defeat deflation.

     This suggests that Howard remains committed to the strategy, a boon for stocks. Other macro hedge funds are said to share a similar view, according to an official at a Japanese pension fund. Hedge funds are "waiting for the global market to settle down and are searching for the next opportunity to carry out their Japan Trade (strategy)," says the official.

Not out of the woods

But there is an area of concern. Of the different stock index futures in Japan, major hedge funds typically favor Nikkei Stock Average futures for their high liquidity. Net selling of Nikkei index futures narrowed in January as each week passed, yet Topix futures continue to suffer widening bouts of net selling.

     Among foreign investors, U.S. pension funds and other long-term investors apparently prefer Topix futures more than short-term investors such as hedge funds. U.S. brokerages known to cater to long-term investors continue to place sell orders for Topix futures, according to TSE data.

     Consequently, Topix futures remain undervalued compared with the index itself. If prolonged, this trend may serve as proof that long-term foreign investors are not as confident in the market and are selling Japanese shares as a result. The return of Topix futures prices to normal may provide a better gauge as to when stock selling by foreign investors has truly ended.

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