Plummeting 26.5% in three trading days, where are Japanese bank stocks headed?

Japanese bank stocks have collectively risen by 9% this year, but they encountered a massive sell-off last week, leading to a sharp decline in stock prices. Despite this setback, some analysts believe that bank stocks are relatively resilient in the Japanese stock market and are expected to rebound.

Japanese bank stocks plummeted, with the decline in U.S. bond yields overshadowing the impact of the Bank of Japan's rate hike

In the first three trading days of August, the Tokyo Stock Exchange Bank Index fell by 26.5%, far exceeding the 20.3% decline in the Tokyo Stock Exchange Index. Both indices experienced the largest three-day drop in at least forty years.

The poor performance of Japanese banks is somewhat unusual: the key trigger for this sell-off is market concerns that the Bank of Japan may continue to raise interest rates after the rate hike on July 31, but higher interest rates are actually beneficial to bank profits.

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Investors had expected higher interest rates to boost bank stocks, but market concerns about a potential U.S. recession overshadowed the impact of the Bank of Japan's rate hike, leading to a decline in Japanese government bond yields, which ultimately dragged down Japanese bank stocks.

Nomura Securities cross-asset strategist Yoshitaka Suda pointed out that shorting Japanese government bonds and buying Japanese bank stocks was one of the most crowded trades among hedge funds, and the sharp decline in Japanese bank stocks led to a massive unwinding of these trades. As investors rushed to unwind their positions, they sold off bank stocks in large quantities as a quick way to exit the trade, contributing to the sharp decline in bank stocks.

Bank stocks are expected to recover

Although Japanese bank stocks have experienced a rare plunge in decades, the outlook for the future remains optimistic.

Yoshitaka Suda believes that high dividend yields are favorable for bank stocks, and he stated:"I don't think bank stocks will continue to be sold off. Hedge funds have already lightened their positions in bank stocks, and considering the attractiveness of dividends from bank stocks, they may be relatively resilient in the Japanese stock market."

Furthermore, for investors who are concerned about the possibility of further appreciation of the Japanese yen, bank stocks have an additional advantage in that they are less sensitive to foreign exchange fluctuations compared to stocks that are more susceptible to exchange rate impacts, such as automakers and trading companies.

After the yen hit a seven-month high of 141.70 against the US dollar, the Japanese currency remains volatile.

Bank of Japan Governor Haruhiko Kuroda stated in a speech on July 31: "As long as the economy develops as predicted, the central bank will continue to adjust interest rates." He did not consider 0.5% to be a special obstacle and urged investors to prepare for the possibility of further rate hikes. This shocked investors, as the market had expected the central bank not to make any further adjustments after raising interest rates to 0.25% this year.

Strategists at BNP Paribas have expressed their preference for banks over automakers, betting that banks will receive higher interest income.