(Bloomberg) -- The outsized drop in bank shares during the recent rout in Japanese stocks has the potential to bring an off-the-scale recovery.
In the first three days of August, the Topix Banks index lost 26.5%, more than the 20.3% fall in the broader Topix index. Both saw their biggest three-day declines in at least four decades.
There were signs Wednesday that the rebound may be underway, with the Topix banks gauge rising 7.9%, beating all other sectors.
The underperformance of Japanese banks during the rout somewhat counterintuitive given that one of the triggers for the latest selloff was a fear that the Bank of Japan may continue to raise interest rates after it hiked on July 31. Higher rates are a boon for bank profits.
BOJ Governor Kazuo Ueda said the central bank will continue to adjust interest rates as long as the economy moves in line with its projections, shocking investors who had bet the BOJ would be done for the year once it raised rates to 0.25%. Deputy Governor Shinichi Uchida sent a strong dovish signal on rates Wednesday, pledging to refrain from hiking interest rates when the markets are unstable.
As if the message wasn’t clear enough, Ueda even went so far as to say he doesn’t see 0.5% as a particular barrier, prompting investors to brace for a series of further rate increases toward next year.
That would have pleased investors who had bet on higher interest rates and a subsequent rise in bank shares. What they didn’t get right, though, was that there would be sharp falls in US bond yields on rising fears of a recession in the world’s largest economy, which overwhelmed the impact of the BOJ and crushed JGB yields.
The fact that shorting Japanese government bonds and buying Japanese banks was one of the most crowded trades among hedge funds such as commodity trading advisers didn’t help, causing a massive unwinding in such trades, said Yoshitaka Suda, cross asset strategist at Nomura Securities.
As speculators rushed to unwind their positions, they sold bank shares heavily as a quick way to get out of their trades as unwinding interest rate derivatives positions could take more time because of a lack of liquidity, he said.
‘Relatively Resilient’
“I don’t think bank shares will be sold off sharply from here,” Suda said, as he thinks hedge funds’ positioning in bank shares has become light. “Considering the attraction of bank shares’ dividends, they may be relatively resilient among Japanese stocks.”
The Topix bank index has a dividend yield of 3.8%, more than one percentage point above the broader Topix.
Bears think the best days for bank shares may be over, given they have advanced so much this year despite their latest collapse. The sector’s stocks have risen 17.5% so far this year, compared with a 5.2% gain in the Topix.
Still, for investors who are worried the yen may have further room to gain, bank shares have the additional benefit of having limited exposure to foreign-exchange fluctuations, compared with more currency-sensitive stocks like automakers and trading houses. The Japanese currency remained volatile after hitting a seven-month high of 141.70 per dollar on Monday. It traded around 147.00 at 3:30 p.m. in Tokyo on Wednesday
Strategists at BNP Paribas including Jason Lui and Yusuke Ikawa say they prefer banks to automakers, betting that lenders will be supported by higher interest income in the medium-term.
(Updates with bank share moves on Wednesday)
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