Short-selling on Tokyo's bourse jumped to the highest on record this month, as the Topix index tumbled 7.7 percent from a six-year high in September.
As bets pile up against Japanese stocks, investors with $293 billion in client assets see the pessimism as a signal to buy. History is on their side.
Short-selling on Tokyo's bourse jumped to the highest on record this month, as the Topix index tumbled 7.7 percent from a six-year high in September. Shares have rallied an average 9.7 percent over the three months following surges in bearish bets since 2009, according to data compiled by Bloomberg.
For Sydney-based AMP Capital Investors Ltd., that's one reason for optimism. The outlook for company profits is another. Government-backed steps to put a floor under Japanese equities may prove dangerous for short-sellers: the central bank says it's ready to add stimulus if the economy falters, while on Oct. 20, a Nikkei newspaper report the country's $1.2 trillion pension fund would buy local shares roused the Topix (TPX) from a three-week rout.
“Fear is hitting extreme levels and it's time to get into the market,” Nader Naeimi, who helps manage about $125 billion as head of dynamic asset allocation at AMP, said by phone on Oct. 14. “When these sentiment indicators flash excessive pessimism, it usually suggests we've reached the lows.”
Bearish bets accounted for 36.6 percent of all transactions on the Tokyo Stock Exchange by value on Oct. 14, according to bourse data compiled by Bloomberg. That's the highest since the exchange started publishing the figures in 2008. The ratio was 33.4 percent on Oct. 24. The Topix climbed 1 percent to close at 1,254.28 in Tokyo today.
PESSIMISM CLIMBS
Pessimism spread as Japanese equities were buffeted from abroad. The Topix tumbled 12 percent in the three weeks ended Oct. 17, meeting the definition of a correction, as concern about a global economic slowdown and the Ebola virus spurred a global rout. The Nikkei Stock Average Volatility Index, a gauge of option prices, surged to an eight-month high on Oct. 17.
With the yen strengthening, losses were biggest in Japanese stocks. Benchmark gauges in the U.S. and Europe dropped 4.9 percent and 6.9 percent respectively during the period.
“The markets are too pessimistic about Japan right now,” John Vail, Tokyo-based chief global strategist at Nikko Asset Management Co., which manages about $168 billion, said in a phone interview on Oct. 20. Corporate profits “are going to continue to surprise on the upside,” he said.
Declines in Japan's currency will be a boon for company earnings and help consumer sentiment, according to AMP's Naeimi. He's holding more Japanese shares than are represented in his global benchmark and betting the yen will weaken further.
When short sales last accounted for more than 36 percent of daily trading in Tokyo, in April, investors saw a 9.5 percent gain in the Topix over the next three months. After the previous surge in bearish bets reached a peak in September 2012, the Topix gained 7.6 percent in the subsequent three months.
On the five occasions that the ratio has peaked since 2009, shares rallied in the next three months all but once. The Topix has advanced 2.3 percent since the record short-sale ratio seen Oct. 14.
For Ayako Sera, a Tokyo-based market strategist at Sumitomo Mitsui Trust Bank Ltd., there's one caveat to bullishness on Japan: what happens in the rest of the world.
“I can't be an all-out optimist because of Ebola, and although less prominent in the news these days, the Islamic State and Ukraine,” Sera said Oct. 22. “Big companies are doing well, with good earnings and the boost from the yen. But Japanese stocks often don't move on domestic reasons.”
Recent economic data in Japan have disappointed. Gross domestic product shrank an annualized 7.1 percent in the three months through June, the most since the first quarter of 2009, the Cabinet Office said Sept. 8. Industrial production declined 1.5 percent in August from July, a report showed Sept. 30.
For Jefferies Group LLC, valuations suggest a rebound this time too. Some 889 of the Topix's 1,811 companies now trade below the value of their net assets, according to data compiled by Bloomberg. This should be a warning to hedge funds taking overly bearish positions, according to Sean Darby, Hong Kong-based chief global equity strategist at Jefferies.
The Topix traded at 13.1 times estimated earnings Oct. 17, the lowest level since May, according to data compiled by Bloomberg. That compared with 15.7 on the S&P 500 that day, the data show.
“People are protecting their positions and I can see the argument from an economic point of view with the data having been on the weaker side,” Darby said Oct. 20. “I can understand that but it's hard to be too short a market where more than half of the companies are trading below book value.”
