Everything seems to be repeating last year, but will the Japanese stock market be different this time?

A year later, the Japanese stock market is at a similar crossroads.

On August 5th last year, an unexpected interest rate hike by the Bank of Japan triggered a significant appreciation of the yen, causing the stock market to plummet by 12% in just one week, with a market value evaporating by over $670 billion.

Now, after experiencing two major sell-offs, the Tokyo Stock Exchange Index is once again approaching historical highs, while unexpectedly weak U.S. employment data has reignited concerns about an economic recession, pushing both the Nikkei 225 Index and the Tokyo Stock Exchange Index down by over 1% on Monday.

Despite the shadow of history looming over the market, many signs indicate that the fundamentals and market environment of Japanese stocks have undergone profound changes, and a repeat of a comprehensive collapse may be avoided.

Market participants generally believe that improvements in the Bank of Japan's communication strategy, the ongoing promotion of corporate governance reforms, and better-than-expected U.S. tariff agreements provide a more solid foundation for the rise of Japanese stocks.

Analysts believe that the key difference lies in the performance pattern of the yen exchange rate, which has fundamentally changed. Unlike last year when Japanese stocks rose alongside a significant depreciation of the yen, this year, when Japanese stocks reached new highs, the yen exchange rate remained relatively stable. This change has eliminated the vicious cycle mechanism of yen appreciation reinforcing stock price declines seen last year.

Surface Similarities Cannot Conceal Essential Differences

The sharp decline of Japanese stocks in August this year indeed reminds one of last year's brutal scene. Citigroup analyst Ryota Sakagami pointed out in a report that both declines stemmed from concerns about a recession triggered by deteriorating U.S. economic data and occurred against a backdrop of strong performance in Japanese stocks.

However, Citigroup noted that there are three key differences between the two declines in Japanese stocks.

First, when Japanese stocks reached new highs this year, the yen exchange rate was relatively stable, whereas last year it was driven up by a significant depreciation of the yen. This indicates that the structure of investors' positions has fundamentally changed, with no longer a large-scale "long Japanese stocks/short yen" position, breaking last year's dangerous feedback loop.

Second, the correlation between the dollar and long-term interest rates has significantly decreased. Last year, the dollar was at a relatively high level, and the decline in long-term interest rates due to recession concerns easily led to a depreciation of the dollar. Now, the dollar and long-term interest rates are completely decoupled, making it unlikely that a decline in interest rates will cause a significant weakening of the dollar.

The third point is that the U.S.-Japan economic surprise index (where a value greater than zero indicates better than expected) is higher than the same period last year, while the inflation surprise index, especially the U.S. index, is significantly lower. This indicates that the likelihood of heightened economic concerns is reduced, and the market is more likely to reach a consensus on interest rate cut expectations.

Significant Improvement in Bank of Japan's Communication Strategy

Additionally, Citigroup stated that the improvement in the Bank of Japan's communication methods is widely recognized by the market.

In July last year, a 15 basis point interest rate hike completely caught the market off guard, leading to a surge in the yen and a global unwinding of interest rate differential trades. Now, the Bank of Japan has established a more transparent communication mechanism, ensuring that at least one board member gives a speech and holds a press conference before each policy meeting. **

Ten days before the interest rate hike in January this year, Bank of Japan Deputy Governor Takao Ueno gave an unusually clear hint, which was subsequently confirmed by Governor Kazuo Ueda.

The results also show the effectiveness of this improved communication method. Although the 25 basis point hike was the largest in 18 years, the market was well prepared, and in the following week, Japanese stocks rose, driven by gains in bank stocks.

Masayuki Koguchi, Chief Fund Manager at Mitsubishi UFJ Asset Management, stated:

"The Bank of Japan decided to raise interest rates again in January after the turmoil last summer and clearly indicated that the rate hike path will continue. It is now easier to envision future rate hike scenarios."

Foreign Investment Favors Structural Improvement, Japanese Stock Market More Resilient

After experiencing the crash last summer and the sharp decline in April due to tariffs, analysts generally believe that the resilience of the Japanese stock market has significantly increased.

Pelham Smithers, an analyst at a UK stock research firm, remarked:

"The two lightning crashes have eliminated some hot money, and those who remain in the market now are the ones who truly believe in Japan."

Among these "true believers," a considerable portion consists of foreign investors attracted by corporate governance reforms in Japan. Record stock buybacks and ongoing governance reforms have led overseas investors to believe that this will release long-term value for shareholders.

Sunny Romo, Director of Japanese Equity Investment at M&G Investments, pointed out:

"Governance reforms and shareholder returns are far from peaking and are climbing to new heights."

Domestic market observers also see more upward potential for Japanese stocks. Following the recent electoral setbacks for the ruling party in Japan, the market anticipates that it may yield to the opposition's calls for a reduction in the consumption tax, which has sparked hopes that retail and other domestic demand-driven sectors will be boosted.

Kazuhiro Sasaki, Head of Research at Phillip Securities Japan, stated:

"The market is in a different position now compared to a year ago. If the government implements fiscal expansion, investors have something to look forward to, especially in domestic demand-driven stocks."

Strategists from major firms, including Goldman Sachs and Bank of America, have recently raised their forecasts for the Tokyo Stock Exchange and Nikkei indices, believing that good progress in the US-Japan trade agreement will result in less than expected impact on the Japanese economy.

Yen Stability Remains a Key Variable, 140 May Become the "Last Line of Defense"

Despite the optimistic outlook, the trajectory of the Japanese stock market remains highly dependent on the stability of the yen.

Klaus Wobbe, CEO of Intalcon Asset Management, warned that ongoing trade concerns and uncertainty surrounding Prime Minister Shigeru Ishiba's fate may still drive safe-haven demand for the yen, leading to market volatility.

Wobbe emphasized that 140 may be the "last line of defense":

"I believe the yen may appreciate again to below 140, especially if the Federal Reserve cuts rates in the fourth quarter while the Bank of Japan tightens policy, which would indicate that real unwinding is taking place, and 140 is the last line of defense Risk Warning and Disclaimer

The market has risks, and investment should be cautious. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at one's own risk