Nikkei volatility keeps equity investors on edge

Employees prepare to work on the trading floor of the Tokyo Stock  Exchange. TSE data shows that domestic individual investors comprised around 28% of trades by value in December, but only 21% by mid-February.

Dow Jones

Tokyo

An increasingly volatile Japanese stock market has forced many traders to think hard about their strategies for 2014.

The market has seen wide price swings recently. The Nikkei Stock Average, the main market barometer, booked its most volatile week of the year in the week through February 21, gaining almost 4%, largely in response to strong US manufacturing data and a higher dollar, both seen as positive for stocks.

But there have been plenty of negative days as well. Overall, the Nikkei saw price swings of at least 1.5% on more than half of the trading days in February.

Such swings have made many investors nervous, pushing up the Nikkei’s implied volatility to 29%, nearly double the levels for the S&P500 VIX index and European indexes, such as Germany’s DAX and France’s CAC 40.

Implied volatility, sometimes known as the fear index, demonstrates the level of concern among investors that the market may fall.

“Japan looks a lot more like a trader’s market, not an investor’s market,” said Adam Fisher, CIO at Commonwealth Opportunity Capital, a US-based hedge fund.

For buy-and-hold investors, the resulting volatility can be discouraging. Amundi Asset Management, with 20bn euros ($27.3bn) invested in Japanese equities, is considering reducing its exposure by the second quarter of 2014 as concerns grow over whether the economy will be able to keep growing, despite a planned increase in Japan’s sales tax due to take effect in April.

Investor uncertainty is evidenced by the fact that after adding 57% in 2013, the Nikkei continues to rank among the world’s worst performing markets, sliding almost 9% through the first two months of the year.

At the same time trading levels have dropped sharply. February volume on the TSE 1st Section totaled just 49bn shares, one of the lowest tallies since the market first began to rally on hopes for more aggressive central bank easing in November 2012. As volume falls, market swings tend to be exaggerated.

Among those largely on the sidelines are individual investors, traders say. “After getting burned in January, they are no longer a factor in the market,” said Kuninobu Takeuchi, executive portfolio manager at Diam Co, an asset manager and one of Japan’s largest pension managers.

TSE data show that domestic individual investors comprised around 28% of trades by value in December, but only 21% by mid-February.

And foreigners-long a dominant force in the market-may have grown weary of the swings as well. After selling a net Yen1.1tn of stock in January, they remain mostly sellers in February, too.

“When individuals pull their money out, there is now nobody to fill the void,” said CLSA equity strategist Nicholas Smith.

Nudgem Richyal, a fund manager at equity fund JO Hambro, said volatility will likely continue through this year due to the impact US monetary policy tightening on global markets.

“The entire Japanese market may not resume upward movement again until 2015,” said Richyal, who manages about $6.5bn in Japanese stocks. He has been picking over the market for bargains, including Yaskawa Electric and Omron, both robotic manufacturers that fell sharply in January.

For a others with the right strategy, however, greater volatility can be a blessing.

“We aim to find profits from market movement, not market direction,” said Chris McGuire, CEO/CIO at Phalanx Capital Management, a Chicago-based convertible bond arbitrage fund.

Sony Corp has been a recent focus of Phalanx, as its price has moved sharply on weak profit forecasts and credit downgrades. McGuire’s fund added 1.1% for January, and around 2% for February, well ahead of the Nikkei.