Nikkei 225, Topix, Nasdaq 100, and S&P 500 meltdown explained

Japan stocks nosedived

Japan stocks had their worst day in years as concerns about the divergence between the Bank of Japan (BoJ) and the Federal Reserve continue. The blue-chip Nikkei 225 index dropped by over 14% and reached its lowest point since November 2023. It has slipped by over 25% from its highest point this year.

Similarly, the Topix index, which soared to a three-decade high of ¥2,947 earlier this year, crashed by over 24% to its lowest level since October last year.

Nikkei 225 drops amid BoJ and Fed divergence

The main reason for the ongoing crash in Japanese stocks is the ongoing divergence between the Bank of Japan (BoJ) and other global central banks. 

In its closely watched decision last week, the bank decided to deliver its second interest rate hike of the year. It initially hiked rates by 10 basis points in its March meeting and then caught analysts by surprise by hiking by 25 basis points. 

The bank also slowed down its quantitative easing policy and hinted that it could deliver more hikes later this year. It hopes that the rate hike will help Japan deal with the stubbornly ‘high’ inflation, which has risen from the year-to-date low of 2.2% to 2.7%.

While these numbers are smaller by global standards, they are substantially higher than where they were a few years ago. Inflation is being driven mostly by the rising wages and higher energy prices in the country.

The BoJ is hiking rates at a time when other global central banks are slashing interest rates. The Federal Reserve has hinted that it will cut rates in its next meeting in September, especially after the weak US jobs data released on Friday.

In Europe, central banks like the Bank of England, Swiss National Bank, European Central Bank, and Riksbank have started cutting rates.

Therefore, the Nikkei 225 and Topix indices crashed as the Japanese yen rallied against other currencies. Japan, as an exporting country, favors a weak Japanese yen since it makes its products affordable abroad. 

Nasdaq 100 vs S&P 500 vs Topix vs Nikkei 225

Winding down the Japanese yen carry trade

Meanwhile, other global stocks tumbled, with futures tied to the Dow Jones, S&P 500, and Nasdaq 100 indices crashing by over 662, 150, and 845 points, respectively. 

In Europe, the German DAX index, FTSE 100, and CAC 40 indices tumbled by more than 2% on Monday. 

Some of the top stocks were down by over 10% in the pre-market session. Tesla slumped by almost 10% while Nio, Nvidia, and AMD slumped by over 14%, leading to billions in losses.

The same trend happened in the crypto market as Bitcoin tumbled to $50,000 and Ethereum slipped by over 25% to $2,100. Other tokens like Cardano, Solana, Dogecoin, and Shiba Inu slumped by more than 20%.

There are several reasons for this crash but a primary one is the winding down of the Japanese yen carry trade. A carry trade is a situation where investors borrow from low-interest rate places and invest in higher rates. 

Japan has always been a good carry trade country because of its low - and often negative - interest rates. Therefore, many investors have started to wind down their carry trade as the spread between the US and Japan narrows.

The other reason for the sell-off is that there is an increasing risk of a US recession. Data released last week shows that the unemployment rate rose to 4.3% last month as the economy created just 114,000 jobs. 

As a result, the so-called Sahm Rule, which has accurately predicted most recessions rose to 0.53%. Goldman Sachs has also raised its odds of a recession. 

Ironically, US and global stocks do well during recessions since the Fed responds by cutting interest rates. For example, US and other global stocks soared after the Global Financial Crisis (GFC) recession in 2009 and after the COVID-19-induced sell-off in 2020.

Dead cat bounce likely

The next few days will likely be volatile for Japan and global stocks. One certain thing is that these assets will have elevated volatility in the next few days. Most of them will also have dead cat bounces in this period.

A dead cat bounce is a situation where a financial asset in freefall stages a brief comeback and then resumes the downward trend. These bounces will happen as some investors buy the dip. In most cases, these rebounds are often brief.

The HypeIndex tool can help you filter the noise by identifying some of the most hyped stocks in the market. As we wrote on Friday, in most cases, hyped stocks often beat the S&P 500 and other indices.