When the 225-issue Nikkei average rallied to a three-decade high earlier this year, some saw its all-time record as finally in sight.

These days, with the gauge having lost steam over the past month, those dreams are looking a little distant. Despite a 2.1% gain on Thursday, the blue-chip index still trades nearly 5% below its February high, with many seeing it remain stagnant in the same range through coming months.

A sell-off through Wednesday was triggered by a number of factors. The government is set to declare another state of emergency amid a surge in COVID-19 cases, while the country lags behind other major economies in its distribution of vaccines.

Exacerbating the situation, the Bank of Japan is dialing back its buying of exchange-traded funds and no longer buys those tracking the Nikkei, while some investors are rotating out of value shares. As Japan’s earnings season kicks off in earnest next week, some expect the current stagnation to continue.

"It’s tough to push equity prices to fresh highs,” said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank Ltd. in Tokyo, who sees the Nikkei 225 trading largely between 28,000 and 30,000 for a while. "Things aren’t recovering to pre-virus days as people thought they would.”

Olympic impacts

Prime Minister Yoshihide Suga plans to decide Friday whether to declare a state of emergency in Tokyo, Osaka and other areas looking to ramp up restrictions to contain a surge in virus cases just three months before the start of the Olympics.

"While countries like the U.S. and U.K. are seeing the light at the end of a tunnel, Japan is still behind in terms of economic reopening,” said Mamoru Shimode, chief strategist at Resona Asset Management. "Although we expect this to be temporary, should Japan lag behind developed countries in vaccine rollout and economic reopening, investors will hold back from increasing their weighting of Japanese stocks.”

Pushing forward with the delayed Olympics could leave a negative impression on Japanese equities for foreign investors, said Mitsushige Akino, a senior executive officer at Ichiyoshi Asset Management in Tokyo.

"The government isn’t likely to call off the Olympics anytime soon,” said Akino. "But if they do decide to go on with the Olympics even when circumstances don’t support it, foreigners will view Japan as a country that isn’t capable of dealing with emergency situations.”

For Frank Benzimra, head of Asia equity strategy at Societe Generale in Hong Kong, the recent underperformance of Japanese stocks has more to do with the "pause” in value trades than the pandemic. "With value again underperforming growth over one month, we find Japan underperforming,” he said.

Overseas investors, who were expected to restore their interest in Japanese equities following years of selling, have yet to show significant demand.

While they bought about ¥1.7 trillion ($15.7 billion) of local equities in the cash market this year through April 9, they’ve offloaded about ¥1.6 trillion in stock futures during the same period, according to Japan Exchange Group.

‘Temporary’ correction

Making matters worse was the BOJ’s absence from the ETF market on Tuesday, despite a 1.2% drop in the Topix during the morning session. That was the first time since at least 2016 that the central bank didn’t buy ETFs after such a drop. In March, the BOJ scrapped its annual purchase target in favor of a more flexible approach.

"The market is taking this as a cut in monetary easing,” said Tomo Kinoshita, a global market strategist at Invesco Asset Management in Tokyo. "We’re at a stage where we could experience some pain as things head toward normalization.”

After a much larger drop of 2.2% on Wednesday, the BOJ did step in to buy ¥70.1 billion of funds, though it no longer buys ETFs that track the Nikkei 225.

On the other hand, many don’t view this week’s downturn as a sign of a complete reversal in the upward trend for Japanese stocks.

"Any downward correction will likely be temporary,” said Kinoshita. "It’ll be a bit of a different story if U.S. stocks fall too, but otherwise I expect local stocks to trade sideways for a while.”

Thursday’s rebound could be a sign of things to come, as Sera of Sumitomo Mitsui Trust Bank sees buyers stepping in when the market drops.

”There probably are a lot of people who are willing to buy," she said. "So whenever the market falls, there will be a tussle between buyers and sellers.”

In a time of both misinformation and too much information, quality journalism is more crucial than ever.
By subscribing, you can help us get the story right.