Bank of America strategists warn that Japanese equities face three key obstacles in August: higher oil prices, a more hawkish US Federal Reserve, and the prospect of crowded positions in both equities and foreign exchange being unwound.
Rising crude costs could feed into broader inflationary pressures, which in turn would strengthen the argument for additional Fed rate increases. The bank's economists expect rate hikes in September, October and December, although the strategists note an earlier move should not be entirely ruled out. Stronger US rate expectations and higher oil may reintroduce downward pressure on richly valued technology names.
Higher oil prices carry a second, Japan-specific risk. They can worsen the country's trade balance and put downward pressure on the yen, which would tend to support a stronger dollar. Bank of America highlights that a rapid move in USD/JPY toward 165 would raise the odds of currency intervention.
On positioning, the bank points to increasing short positions in the yen tied to foreign investors hedging their Japanese equity holdings. When combined with heavy concentration in artificial intelligence-related stocks, this positioning resembles the setup seen before last August's volatility spike, according to the strategists.
Seasonality may compound these pressures: August typically exhibits lower liquidity, and historical patterns offer little tailwind for momentum and high-beta names until about mid-month. However, the strategists note that if US employment and inflation prints released in early August are softer than expected, market conditions could begin to stabilise from mid-month onward.
Despite the immediate obstacles, the bank expects Japanese stocks to recover toward the end of the year once these near-term challenges have been navigated.
On positioning advice, Bank of America recommends that investors retain some exposure to AI-related investments but avoid firms whose valuations have risen excessively. The strategists suggest attention could rotate away from semiconductor companies driven by hopes for higher chip prices toward firms that stand to benefit from increased data-centre investment volumes. Specific areas cited include optical communications, network infrastructure, semiconductor materials, power equipment, cooling systems and water treatment.
In addition to selective AI-related opportunities, BofA prefers diversifying into lower-beta domestic businesses. Sectors mentioned as attractive on a relative basis include retail, services, food, healthcare, gaming and information technology that have more domestic revenue and lower sensitivity to global growth and FX swings.
Implications for markets and sectors
- Energy: A rise in oil prices would be directly supportive for crude-related assets but could exacerbate inflationary dynamics.
- Technology: Richly valued tech and AI-linked stocks are vulnerable to both higher rates and shrinking liquidity; select parts of the tech supply chain tied to data-centre builds may outperform.
- Domestic sectors: Retail, services, food, healthcare, gaming and domestic-facing IT could offer lower-beta exposure during periods of FX and rate volatility.
The strategists emphasise that the near-term environment is conditional on incoming macro releases. If early August US data is subdued, some of the pressures could ease by mid-month, supporting a recovery in Japanese equities toward year-end. Until then, investors face a landscape shaped by commodity dynamics, central bank policy direction and crowded positioning in both stocks and currencies.