If the yen falls below the "bottom line", how will Japanese stocks go in the future? The key depends on the Federal Reserve and crude oil

On Friday, April 26, the JP/USD pair fell below 156 to a new low for the first time since June 1990.

Since the beginning of this year, the "falling and falling" yen has continued to support Japanese stocks, and the Nikkei 225 index has risen nearly 14%.

Next, can a weaker yen continue to support Japanese stocks?

On April 23, Bank of America Merrill Lynch released its latest research report, deducing three scenarios for the future trend of Japanese stocks, among which the Fed's interest rate path and crude oil trend will become important influencing factors.

The report pointed out that as long as there is no surge in crude oil and the Federal Reserve starts an intensive interest rate hike cycle, Japanese stocks are likely to rebound.

Three possible scenarios for Japanese stocks in the future

The report proposes three scenarios that Japanese stocks may face:

The first scenario: the US economy remains strong, but it is suppressed by high interest rates and a strong dollar. The Federal Reserve is expected to cut interest rates in December, and global financial conditions could ease somewhat if the risk of a surge in crude oil prices subsides.

The second scenario: the rise in crude oil prices leads to a tightening of financial conditions (similar to the second half of 2023). If the data shows a rapid slowdown in the economy, it could pave the way for the Fed to cut interest rates.

The third scenario: the price of crude oil soars, causing the Federal Reserve to start a second round of intensive interest rate hikes, and the overall risk rises.

According to the report, the first scenario is the main scenario, the second scenario may occur, and as long as the third scenario is avoided, Japanese stocks may rebound.

The report also added that in the first scenario, the premium for crude oil is expected to remain between $5-$10 per barrel, and once the Iran-Israel conflict escalates into a full-scale war, the third scenario will occur, resulting in crude oil prices above $150 per barrel for a long time, but if the Fed can cut rates in July or September, then the market will have a lot of room to rebound.

In general, there is a positive correlation between earnings per share (EPS) and crude oil prices, and rising oil prices usually indicate that the global economy is in a recovery phase, which supports EPS, but if oil prices soar more than expected, this model will no longer be tried.

In terms of stock types, Bank of America Merrill Lynch believes that value stocks will outperform the broader market, low-volatility defensive stocks will also remain strong, and if the dollar stops rising, stocks geared to domestic demand and late-cycle manufacturing stocks may rise.

The medium-term outlook for Japanese stocks has not changed

The report mentions that although the valuation of the Japanese stock market has been adjusted, it has not yet corrected to a level that can be confirmed as a bottom.

During a period when global financial conditions are slowing and foreign investors' risk tolerance is increasing, the price-to-earnings ratio of Japanese equities tends to rise sharply. Conversely, when financial conditions deteriorate, the gears turn in the opposite direction.

At present, the financial situation has turned back to a deteriorating state, and the over-inflated P/E ratio is returning to a level consistent with earnings.

According to the report, the medium-term outlook for the Japanese stock market has not changed, and the weakening of the yen, triggered by rising US interest rates, will ultimately contribute to inflation in Japan.

If next year's "spring fight" continues to be forced, the virtuous cycle of wages and prices will be more stable, and in addition, the subsequent corporate governance is expected to consolidate the rally of Japanese stocks.

Although the turbulence in the financial environment seems to have led to a withdrawal of foreign capital from the Japanese stock market, there is still a lot of room for long-term funds to be weighted by it.

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