Behind the new highs in the Japanese stock market: Valuation traps under the "double kill" of exchange rate and interest rate expectations?

Recently, the Japanese stock market has reached new heights, but the foundation of this rally may not be solid. According to news from the Chasing Wind Trading Desk, the latest research report by Nomura analyst Naka Matsuzawa suggests that although the Japanese stock market is hitting historical highs, this rally is more a valuation correction relative to the US and European markets rather than a comprehensive bull market driven by fundamentals. The report states that the rising expectations of interest rate cuts by the Federal Reserve are suppressing expectations for interest rate hikes by the Bank of Japan. Currently, the market's expectation for the probability of a rate hike this year is only 57%, far below the peak level of 84% after the US-Japan trade agreement. In addition, the weak performance of technology stocks and bank stocks has become a key constraint on the sustainability of the Japanese stock market's rally. The report indicates that under the pressure of the yen and the setback in expectations for interest rate hikes by the Bank of Japan, if the key technology and banking sectors cannot provide sustained momentum, this record-breaking market may just be a "valuation trap." Bank of Japan's Interest Rate Outlook Restricted by Federal Reserve's Rate Cut Expectations Despite the Bank of Japan's hawkish rhetoric, market confidence in its rate hikes is wavering. The report points out that although the "Summary of Opinions" released by the Bank of Japan last Friday sent clear hawkish signals, even suggesting that it might exit its current wait-and-see stance "as early as the end of this year," market expectations for rate hikes have not warmed up accordingly. The most critical dynamic is that the market's expectations for an imminent rate cut by the Federal Reserve are offsetting the Bank of Japan's hawkish stance. The report notes that after disappointing US employment data, the market is almost certain that the Federal Reserve will cut rates in September. This external factor is dominating market sentiment, suppressing Japan's interest rate outlook and having a direct impact on the foreign exchange market. According to the report, the market currently expects the probability of the Bank of Japan raising rates this year to be only 57%, far below the peak level of 84% reached after the US-Japan trade agreement. Meanwhile, the two-year forward overnight index swap (OIS) rate, as a forward terminal rate expectation, is only 0.99%. Valuation Correction Rather Than Fundamental Driven , Key Sectors Absent Collectively The report emphasizes that the recent rise in Japanese stocks is more like a "correction of their undervalued levels relative to other national markets," rather than the beginning of a comprehensive bull market. The report shows that the valuation of the Japanese stock market has long been at a discount relative to the US S&P 500 index and the European Stoxx 600 index, and the recent rise has a clear chasing nature. Another major piece of evidence supporting this view is the collective absence of key sectors. In the recent rise of Japanese stocks, the sectors related to overseas demand have not been as strong as expected, especially the lagging performance of technology stocks, indicating that investors do not view this rally as a comprehensive cyclical recovery. At the same time, the bank stocks, which played a key role in the last stock market rebound, have only risen in line with the broader market this time, failing to break through previous highs. The report believes that Nomura's analysis indicates that the underlying reason is the aforementioned interest rate hike expectations have not fully recovered, directly affecting the future profitability prospects of banks. Unless both sectors show strong momentum, the market is unlikely to continue reaching new highs. Yen bulls retreat, speculative positions further decline The movements in the foreign exchange market provide evidence of potential risks for the stock market. According to data from the Commodity Futures Trading Commission (CFTC) as of August 5, despite a disappointing U.S. employment report that temporarily weakened the dollar, speculative investors further reduced their long positions in the yen. Data shows that the scale of long positions in the yen has dropped to 46% of the peak on April 29. Against the backdrop of the USD/JPY exchange rate rising to the 148.0-148.5 range, the bearish sentiment among speculators towards the yen casts a shadow over the prospects of export companies that rely on a weak yen, adding uncertainty to the future direction of the stock market