(Bloomberg) -- The long-held precept that a weak yen is a good thing for Japanese stocks may finally be put to rest, as the breakdown in their correlation accelerates amid divergence in global monetary policy.
Since its big summer crash, the Topix has been stuck in a narrow trading band even as the yen has swung between a 14-month high of 139.58 per dollar in mid-September and a mid-November low of 156.75, which was not far from its 38-year trough in July.
The Topix and the yen have been largely moving independently over the past two months, with the coefficient of determination — a measure of linkage between two separate data — almost zero. That’s far below the 0.50 mark that is often considered indicating some kind of relationship.
Hiroshi Watanabe, senior economist and the head of financial markets research at Sony Financial Group Inc., thinks the Bank of Japan’s monetary policy is the root cause of the breakdown in this correlation.
The market’s trend changed in May, he said, when the central bank shifted its focus to reining in inflation caused by the cheap yen, rather than supporting a virtuous cycle in wages and prices. Foreign investors didn’t like that, becoming net sellers of Japanese stocks since then, he added.
“Since May, investors have come to think that a cheaper yen will prompt the Bank of Japan to hasten interest rates hikes,” Watanabe said. “That in turn is pushing down the multiples of Japanese stocks.”
Watanabe thinks Japanese equities will stay under pressure as long as the BOJ’s stance is more hawkish than the Federal Reserve’s. That likely means at least several more months, with the BOJ seen on track for more rate hikes and the Fed seen cutting rates further.
NOTE: Dots plot the daily close in Topix versus the yen to determine the coefficient of determination (R-squared). A value of 1.0 indicates 100% correlation, while a value of 0.0 suggests no correlation.
Japanese stocks’ past tendency to rise on a weaker yen stemmed partly from a historical perception that the country has a heavily export-driven economy. In reality, it’s been mostly running a trade deficit since 2019. It is the only major economy in the world that has seen virtually zero growth in exports over the last 10 years.
Against that backdrop, a strong yen in fact benefits many firms, said Neil Newman, head of strategy at Astris Advisory Japan.
“There is still this legacy idea that Japanese corporate earnings are sensitive to the yen,” he said. “It’s actually the other way around now. The weak yen is bad. It’s not an exporting economy anymore.”
A strong yen would lower input costs, and help corporate profit margins because their product prices would come down more slowly than those input costs, he added.
Of course, some exporters such as Toyota Motor Corp. can still gain from a cheaper yen. Many analysts estimate that, on an aggregate level, a weaker yen is positive for Topix earnings overall.
Many companies have greatly reduced currency impact, however, by shifting production bases overseas and implementing careful hedges. Some such as Hitachi Ltd. and Sony Group Corp. now have very small forex exposure, after years of business restructuring.
There are signs that investors have become more savvy as well, with knee-jerk stock index reactions to sways in the yen largely a thing of the past.
Akemi Hatano, chief quants strategist at SBI Securities Co., said her analysis shows investors prefer companies with high overseas sales ratios but low sensitivity to the yen. That style of stock picking is different from 2022, when companies with strong forex sensitivity were favored, she said.
“Rather than buying cheap yen beneficiaries, investors appear to be cautiously taking risk in foreign demand-oriented stocks through careful stock selection,” Hatano said.
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