Nasdaq Faces New Risk Beyond Treasuries

The landscape of global finance is ever-evolving, and recent developments in Japan's economic indicators signify a pivotal moment, particularly in relation to the anticipated normalization of its monetary policyAs experts, including Dhaval Joshi from BCA Research, underscore the changing tide in Japan’s inflation expectations, there is growing concern about the potential reverberations it may have on markets worldwide, especially in the United StatesWith inflation in Japan inching closer to the targeted rate of 2%, the longstanding stance of maintaining a zero-interest-rate policy by the Bank of Japan (BOJ) is increasingly called into questionThis shift is of paramount importance as it unveils a scenario where the foundation supporting vast global liquidity may begin to crumble.

Japan’s economic identity has, for years, been characterized by ultra-low interest rates and an intricate financial apparatus that held the fort against inflationYet, this status quo appears poised for changeAnalysts have noted that the persistence of zero rates, primarily justified by inflation rates stagnating below the BOJ's benchmark, is losing its validityRecent trends indicate a movement towards inflation normalcy, which not only pressurizes the BOJ to recalibrate its approach but also raises a red flag about the cascading effects this could have on the international financial ecosystem.

The interconnection between Japanese monetary policy and American markets, particularly the Nasdaq, cannot be overstatedJoshi's analysis captures this relationship succinctly by illustrating how closely the valuations of Nasdaq stocks have mirrored the trajectory of U.S. real bond yields from 2019 to 2022. This alignment was predictable as economic principles suggest that bond yields and stock valuations are often inversely correlated; as yields rise, stock valuations face downward pressureHowever, an intriguing shift occurred by the end of 2022, where instead of adhering to U.S. yields, Nasdaq valuations became tethered to Japan's once-negative bond yields

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This divergence raises significant questions about the sustainability of current stock valuations in light of potential Japanese "tightening."

The reality that we are faced with from 2023 to 2024, as indicated in Joshi's evaluations, suggests that rather than U.S. bond yields impeding tech stock valuations, the rising tide of Japanese bond yields holds a greater threatAs it stands, the absence of significant elevation in Japanese real rates has meant that the valuations of U.S. tech stocks have remained buoyantHowever, over a projected horizon of one to two years, it is expected that Japanese yields will inevitably ascendThis anticipated increase would effectively withdraw one of the key drivers of stock market performance in 2023 and 2024, leading to a consequential recalibration in stock valuations.

The implications of this anticipated shift are starkJoshi foresees that within this structural timeframe, especially for high-profile U.S. technology stocks, a significant recalibration relative to bonds is likely to unfoldInvestors are urged to closely monitor specific economic indicators, including the dollar-yen exchange rate and the correlation between the Nasdaq index and U.S. 30-year Treasury bondsThese indicators might serve as precursors to a potential market reversal, highlighting the fragile balance of global financial dynamics.

The potential repercussions of delayed action by the Bank of Japan have been echoed by other financial analysts, including Xu Xiaoqing from Dunhe Asset ManagementIn a broader analysis, Xu argues that periods characterized by abundant liquidity have coincided with surges in both gold and U.S. equitiesHe posits a scenario where the BOJ's potential pivot towards tightening could be likened to a “grey rhino” event; an outcome that is imminent and visible yet underestimated in terms of its impact.

Xu points to the dangerous precedent set by the BOJ, likening its cautionary stance on interest rate hikes to the Federal Reserve's miscalculations during 2021 when inflation began to trend upward