Nikkei 225 Index: Buying the Dip? Bank of America Provides the Answer

Investing.com - U.S. bank strategists say that the sharp fluctuations in the Japanese stock market may be approaching a turning point.

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The Nikkei Volatility Index recently surged above 50—an uncommon level in history—possibly indicating that after a period of intense sell-offs related to tightening financial conditions and geopolitical uncertainties, the market is nearing a bottom.

U.S. bank strategists Masashi Akutsu and Tetsuhiro Tokuyama stated in a report that the spike in volatility “may reflect a certain panic sentiment among investors, which is a potential sign of market bottoming.”

The strategists pointed out that recent sell-offs in Japan’s stock market are not only due to Japan’s status as a non-resource-based economy being impacted during oil price surges but also due to shifts in investor positioning. As oil prices rise and financial conditions tighten, previously crowded trades are beginning to unwind.

Stocks related to themes like artificial intelligence and defense had previously surged but then fell sharply, while IT services and other previously underperforming tech stocks posted positive returns despite broader macro headwinds. The strategists noted that these movements reflect fundamental factors as well as “largely a result of position unwinding.”

Domestic factors have also amplified volatility. Pension funds and financial institutions may sell stocks before the end of Japan’s fiscal year, and rising bond yields are prompting investors to realize gains in stocks to offset unrealized losses in fixed income holdings.

Despite the intense fluctuations, U.S. banks believe the Nikkei index could gradually rebound after the current surge in volatility. The strategists wrote, “The market is approaching a bottom and should start to recover gradually from April, but it is still too early to confirm.”

The direction of the Japanese stock market will largely depend on developments in the Middle East and oil prices. If tensions between Iran and Israel ease and oil prices fall, market sensitivity to geopolitical risks may diminish, helping stabilize stocks.

However, the team warned that if crude oil prices remain high, risks will persist. Sustained prices above $100 could weigh on corporate profits, hinder real wage growth, and increase the likelihood of further tightening in the global financial environment.

In such a scenario, U.S. banks expect high-quality and defensive stocks less affected by macroeconomic headwinds to outperform the broader market. Conversely, if the oil shock subsides more quickly, high-beta and momentum stocks that declined during the volatility spike may rebound.

Currently, strategists expect stock selection to remain mixed during periods of elevated market volatility.

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