JPMorgan-Asia Pacific Equity Derivatives Highlights Japan equity flow...-107600977

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Global Quantitative & Derivatives

Strategy

15 April 2024

JPMORGAN

www.jpmorganmarkets.com

Global Quantitative and Derivatives

Strategy

Tony SK Lee AC

(852) 2800-8857

tony.sk.lee@jpmorgan.com

Haoshun Liu

(852) 2800-7736

haoshun.liu@jpmorgan.com

J.P. Morgan Securities (Asia Pacific) Limited/ J.P.

Morgan Broking (Hong Kong) Limited

•Recent data from exchanges shows that foreign investors’ year-to-date

purchases of Japanese equities exceed the total for the entire 2023. This

increased involvement of foreign investors raises questions about how

Japanese equities may react to external factors, especially considering the

current scenario of prolonged high interest rates and geopolitical tensions. In

this context, we examine the behavior of major investors in the Japanese equity

market, aiming to uncover insights on the direction of the market .

•Japan equity flow trends: Investment behaviors and flow trends within the

Japanese equity markets reveal distinct patterns among various investor

categories, largely driven by their strategic goals and market perceptions.

Foreign investors display a strong momentum bias, often buying during market

upswings and selling in downturns. Recently, foreign investors have shown

increased activity, purchasing the largest amount of equities in a single week

since April 2013, during the week ending April 5, 2024. In contrast, trust banks,

key in managing pension fund rebalancing, tend to follow a mean-reversion

strategy, selling high-performing assets to rebalance portfolios and purchasing

during market downturns. Year-to-date, trust banks have consistently sold

equities, totaling JPY 5 trillion in sales. Other investor groups such as business

companies, investment trusts, and retail investors also exhibit a mean reversion

bias in their trading activities. Notably, business companies have slowed their

equity purchases compared to previous years, while retail investors have

turned equity buyers since March 2024.

•Reading the flow signals: Investor flow signals offer valuable insights into the

risk-on and risk-off states of Japan’s equity markets, with foreign investors

typically exhibiting momentum bias and domestic investors displaying mean-

reversion bias. Monitoring these behaviors alongside market performance can

guide investors in navigating market volatility. Our risk state detection

methodology incorporates three key inputs—Japan equity index returns,

foreigner flows, and domestic institutions flows. We identify four scenarios

associated with risk-on and risk-off states and analyze forward return and

volatility distributions to anticipate market outcomes. Presently, our signals

indicate a neutral risk state, with potential for a transition to a risk-off state if

the market continues to trade at the current level before end of month.

•Trades to balance risk and reward: We offer a range of strategies for investors

looking to manage their exposure to the Japanese equity market. Our equity

strategists maintain a positive outlook on Japanese equities. From a technical

perspective, we observe increasing short gamma positions among dealers on

the downside, alongside high positioning by CTAs. These factors suggest that

share prices may adjust more rapidly on declines than on increases. We

recommend TPX calls contingent on SPX lower for bullish Japan investors,

NKY resettable puts to maintain portfolio hedges, and selling put spreads on

the NKY to finance the purchase of SPX puts as a relative value play.

See page 12 for analyst certification and important disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that

the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single

factor in making their investment decision.

Asia Pacific Equity Derivatives

Highlights

Japan equity flow trends; Reading the flow signals;

Trades to balance risk and reward

Tony SK Lee AC

(852) 2800-8857

tony.sk.lee@jpmorgan.com

Global Quantitative & Derivatives Strategy

15 April 2024 JPMORGAN

Analyzing investor flows to gauge risk states

in Japan’s equity markets

Recent data from exchanges shows that foreign investors made significant purchases

of Japanese equities in the week ending April 5, 2024, despite the market operating

within a narrow trading range. These investors collectively purchased a net total of JPY

1.18 trillion in cash equities, marking the largest weekly inflow since April 2013.

Their renewed interest has driven their year-to-date purchases of Japanese equities

above the total for the entire 2023. This increased involvement of foreign investors

raises questions about how Japanese equities might react to external factors,

especially considering the current scenario of prolonged high interest rates and

geopolitical tensions. In this context, we examine the behavior of major investors in the

Japanese stock market, aiming to uncover insights into potential impacts on the

direction of equity market trends.

Table 1: Foreign investors’ renewed interest has driven their year-to-date purchases of Japanese stocks above the total for the entire 2023

Source: Bloomberg Finance L.P., J.P. Morgan Equity Derivatives Strategy. Note: Data as of April 5, 2024.

Japan equity flow trends

The primary investors in the Japanese equity markets encompass a range of entities,

such as investment trusts, business companies, financial institutions (including life and

non-life insurance companies, city and regional banks, and trust banks), individuals,

foreigners, and securities companies, as defined by the exchange. By analyzing the

correlation between their respective investment patterns and equity market performance,

these investors can generally be categorized as either momentum-driven or mean-

reversion-oriented (Figure 2Japan equity investors can generally be categorized as either momentum-driven or mean-reversion-oriented). Investor behavior is shaped by a variety of factors,

including strategic objectives, psychological influences, and perceptions of market

conditions. In this analysis, we present an overview of the investment behaviors and

flow trends observed within each major investor category.

Tony SK Lee AC

(852) 2800-8857

tony.sk.lee@jpmorgan.com

Global Quantitative & Derivatives Strategy

15 April 2024 JPMORGAN

Figure 1: Distribution percent of market value owned by type of

shareholder

Source: Bloomberg Finance L.P., J.P. Morgan Equity Derivatives Strategy, TSE. Note: data as of

end-2022.

Figure 2: Japan equity investors can generally be categorized as either

momentum-driven or mean-reversion-oriented

Source: Bloomberg Finance L.P., J.P. Morgan Equity Derivatives Strategy.

Foreign investors demonstrate a significant momentum bias, as evidenced by a strong

flow and return correlation of 47%. This behavior is characterized by their tendency to

purchase equities during market upswings and sell during downturns. Their decision-

making likely relies heavily on observable trends and macroeconomic indicators rather

than localized market knowledge. Additionally, foreign investors often exhibit herding

behavior, following the successful investment choices of others. For instance, a surge in

foreign buying observed since April 2023 was sparked by Warren Buffett's investment

in Japanese trading companies. Many foreign investment entities, particularly hedge

funds, favor momentum strategies due to their historical profitability and diversified risk

profile. Notably, foreign investors transitioned from net selling Japanese equities

between 2020 and 2022, to becoming significant buyers since 2023. Recent data from

exchanges shows that foreign investors collectively purchased a net total of JPY 1.18

trillion in cash equities, marking the largest weekly inflow since April 2013. Their

renewed interest has driven their year-to-date purchases of Japanese equities above the

total for the entire 2023.

Trust banks’ trading activities in the equity market are significantly influenced by

pension fund rebalancing and their role in executing the BoJ’s ETF purchases. Japan’s

pension funds typically adhere to portfolio weight targets, which means they often sell

assets that have performed well and reallocate funds into underperforming assets to

maintain their desired balance. Additionally, trust banks, often acting on behalf of the

BoJ, also play a role in stabilizing the market by purchasing equity during times of

weakness. This tendency to buy low and sell high contributes to a mean reversion bias

in trust bank flows. With Japanese equities exhibiting strong performance, trust banks

have been substantial sellers this year. In fact, trust banks have sold Japanese equities

every week this year, with total sales amounting to JPY 5 trillion.

Business companies’ trading activities are often influenced by strategic decisions such

as share buybacks and the unwinding of cross-shareholdings. Japanese companies,

encouraged by TSE reforms and bolstered by ample cash reserves, increasingly

undertake share buyback programs to return value to their shareholders. These buybacks

typically occur when companies perceive their stock prices to be undervalued, resulting

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GlobalQuantitative&DerivativesStrategy15April2024JPMORGANwww.jpmorganmarkets.comGlobalQuantitativeandDerivativesStrategyTonySKLeeAC(852)2800-8857tony.sk.lee@jpmorgan.comHaoshunLiu(852)2800-7736haoshun.liu@jpmorgan.comJ.P.MorganSecurities(AsiaPacific)Limited/J.P.MorganBroking(HongKong)Limited•Recentd...

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