Wall Street banks warn of potential sell-off in Japan’s stocks

Japanese top-performing stocks are facing a potential sell-off due to overcrowded long positions in liquid and large companies, Reuters reported citing strategists from Morgan Stanley and JP Morgan as saying on Thursday.

Overseas investors are favouring large-cap stocks and following benchmark index products, an approach that led to inflated values in popular sectors like semiconductors and banks.

Trend-following investors using statistical models are also concentrating on a narrow set of stocks, which could prompt them to unwind some positions.

Despite the ongoing rally in Japanese stocks, there are concerns about the sustainability of the trend.

Commodity trading advisors (CTAs) have started reducing their long positions in Nikkei 255 futures, indicating a potential slowdown in buying momentum.

Large-cap Japanese stocks have shown signs of losing momentum, with some stocks posting lower gains in March compared to February.

Morgan Stanley analysts anticipate short-term headwinds for momentum stocks in sectors like semiconductors, automobiles, and financials in April.

Stocks like Tokyo Electron gained 56 per cent, Toyota Motor Corp rose 49 per cent, and Mitsubishi UFJ Financial Group increased 30 per cent, but valuations in certain sectors are considered stretched.

The Nikkei index has surged 22 per cent in 2024 and 40 per cent over the past year, outperforming major global markets, but concerns about high valuations persist.

The current price-earnings ratio for the Nikkei is higher than its 10-year average and comparable to the U.S. S&P 500 index, indicating that Japanese companies may be overvalued despite lower valuations than in 1989.