(Bloomberg) -- Japan has seen its own version of the great rotation trade on Wall Street, with investors shifting more attention from big tech stocks that feature in the Nikkei 225 to the much larger universe of small-to-mid cap companies.
The risk now is that it may reverse, with strategists increasingly concerned that the prospect of rising interest rates in Japan will weigh on smaller businesses that are vulnerable to rising borrowing costs.
The TSE Growth Market 250 Index, formerly known as the Mothers Index, has climbed more than 10% since the start of June, at the same time as US small-cap stocks rallied on expectations the Federal Reserve will lower rates. In Japan though, the longer-term picture is for higher rates from its central bank.
And the TSE Growth Market 250 is still down more than 3% this year, while the Topix’s index of the 30 most liquid stocks with the largest market capitalization is up almost 30%.
“Small- and mid-cap stocks, such as those in the TSE’s growth market, have a lower level of earnings recovery compared with large firms,” said Nobuhiko Kuramochi, market strategist at Mizuho Securities Co. “They’re typically financially weak and they’re less immune to higher borrowing costs.”
The underperformance illustrates how smaller companies may bear a heavier burden should Japan’s central bank officials raise interest rates when they gather to set policy at the end of the month. One in three BOJ watchers expects the bank to raise rates in July, according to a Bloomberg survey last month.
Japan’s small-cap shares had rallied as their peers gained in the US on the prospect of rate cuts, and expectations Donald Trump will push for lower taxes and monetary easing should he become the nation’s next president. Even that momentum could falter now that there are signs a weeklong decline in megacap technology stocks is starting to encompass smaller firms in the US.
On the flipside, a rebound in the yen from higher rates may provide support for shares of smaller companies, which are wary of the currency’s impact via higher import costs. The yen blew through the 156 per dollar level on Thursday for the first time since June, as investors continued to be on edge since suspected intervention by Japan last week.
There needs to be a clear shift in the yen and inflation for a full-fledged and sustained recovery in small-cap stocks, said Masanari Takada, a quantitative and derivatives strategist for Japan at JPMorgan Securities Japan Co.
Hideyuki Ishiguro, chief strategist at Nomura Asset Management Co., agrees the recent rally won’t stay for long, saying the move has been driven by the unwinding short-term positions.
“The growth market’s high stock price doesn’t look sustainable given the lack of earnings support,” he said.
(Adjusts headline and first two paragraphs.)
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