After the surge in Japanese stocks, multiple indicators have turned red!

The US-Japan trade agreement has pushed the Japanese stock market to a historic high, but beneath the celebration, memories of last year's market crash are being rekindled.

On Wednesday, CCTV News reported that Japan and the United States reached an agreement on tariffs, with the US imposing a 15% tariff on Japan. This news propelled the Tokyo Stock Exchange Index and the Nikkei 225 Index to rise more than 3% cumulatively on Wednesday and Thursday. On Thursday, the Tokyo Stock Exchange Index, which tracks over 2,000 companies, rose 1.7% to close at 2,977.55 points, surpassing the historical high set on July 11, 2024.

However, the rapid rise of Japanese stocks is raising concerns about a potential correction. Several technical indicators are nearing dangerous levels seen before last year's market crash, and the possibility of history repeating itself may be increasing.

Data shows that the 14-day Relative Strength Index (RSI) of the Tokyo Stock Exchange Index was about 79 on Thursday, significantly above the 70 threshold typically considered overbought. This level is similar to that in July 2024, less than a month before the market experienced a significant correction.

Additionally, according to analysis from Rakuten Securities, the Tokyo Stock Exchange Index is currently more than 5% above its 25-day moving average, a deviation level that historically often precedes market corrections. For example, in September 2021 and March 2022, the market declined after the deviation exceeded 5%.

Finally, the current rally has not been accompanied by a significant increase in trading volume, similar to the pattern seen in July of last year, suggesting that market confidence in this rally may not be strong.

The shift in market sentiment is also reflected in analysts' statements. Hisashi Arakawa, head of equities at Abrdn Japan Ltd., stated, “When the market rises so quickly, I do think we need to be cautious about what happens in August.”

This cautious sentiment is set against the backdrop of the market crash in August 2024, triggered by the Bank of Japan's unexpected interest rate hike, hawkish comments from Governor Kazuo Ueda, and concerns about the US economy, which collectively led to a stock market plunge. Although the current macro drivers have shifted to the US tariff policy, the similarity in technical indicators is enough to prompt investors to reassess risks.

High Valuations Face Profitability Tests

In addition to the technical warnings, as Japan enters the peak earnings season, the market's valuation levels will face a direct test of profitability.

Rieko Otsuka, a strategist at MCP Asset Management Japan, pointed out that as the market enters the "summer drought" period in August, shrinking trading volumes may exacerbate volatility. She added that as Japan enters the peak earnings season, some companies may maintain cautious performance outlooks when assessing the impact of tariffs, meaning that “stock valuations need to be validated by earnings.” Data shows that the forward price-to-earnings ratio of the Tokyo Stock Exchange Index is currently 15.7 times, very close to the level of 15.87 times before the decline in August last year. Although it still appears cheap compared to U.S. stocks, investors are closely watching whether corporate earnings can keep pace with the rise in stock prices.

Fiscal Pressure Cannot Be Ignored

One of the driving forces behind this round of increases is the continuous influx of foreign investors. According to statistics, global funds have net bought Japanese stocks for 15 consecutive weeks. However, beneath the optimistic sentiment, some potential risks still exist.

Anna Wu from VanEck warns that domestic political and fiscal issues in Japan cannot be overlooked. She points out that the ruling coalition led by Prime Minister Shigeru Ishiba is under pressure, and concerns about Japan's fiscal situation have pushed government bond yields to historic highs.

She believes that if the issuance of Japanese government bonds continues to be weak, it will bring new complexities to the stock market.

For global investors focusing on Japan, stability and predictability are crucial