Bank of America has concluded that Japanese equities may have established a near-term low, following a sharp rise in market volatility that the brokerage notes has historically aligned with market troughs. Nonetheless, the firm stresses that the market outlook is highly contingent on geopolitical dynamics, particularly the unfolding conflict in the Middle East.
According to the brokerage, the recent drop in Japanese share prices was intensified by a mix of factors. Japan's dependence on imported energy magnified sensitivity to supply shocks, while a rapid unwind of crowded trades - most prominently positions linked to artificial intelligence - amplified downward pressure. Investors had rotated heavily into high-growth, AI-associated stocks, and the reversal of those positions produced outsized declines as exposure was pared back.
BofA identified a stabilization in energy markets as a potential catalyst for a rebound. The report highlights the potential influence of rising gasoline prices - particularly as the U.S. approaches the summer driving season - on both policy responses and investor sentiment. Should energy costs continue to rise as a result of supply disruptions connected to the Strait of Hormuz, the brokerage warns that pressure on global markets is likely to persist.
The analysis emphasizes Japan's particular vulnerability as a non-resource economy. A sustained disruption in flows through the Strait of Hormuz would not only reduce crude oil availability but also affect a broader range of commodities - including LNG, coal, and industrial metals - which could push up input costs across multiple sectors.
BofA further notes that if geopolitical tensions ease in the coming weeks, Japanese equities could rejoin a longer-term upward trajectory. This potential recovery would be underpinned, the brokerage says, by solid corporate fundamentals, stable earnings revisions, and ongoing participation from foreign investors. Conversely, failure to resolve the tensions could trigger renewed volatility and possibly drive markets below the recent lows.
On investor positioning, the report observes that market participants have recently favored companies offering stable growth and high returns amid heightened uncertainty. At the same time, BofA points out that high-beta and AI-linked names retain the potential to rebound sharply if market conditions improve.
Looking further out, the brokerage highlights energy-related and resource-linked companies as possible medium-term beneficiaries of the current environment. The episode, BofA suggests, underscores the growing importance of energy security and the resilience of supply chains in investment considerations.
Key takeaways:
- Recent volatility spike likely marked a short-term market bottom, but sustainability of any rebound depends on macro and geopolitical developments.
- Japan's reliance on imported energy and the unwinding of crowded AI-linked trades were major amplifiers of the recent decline.
- Energy and resource-related firms could benefit in the medium term as energy security and supply resilience rise in importance.
Risks and uncertainties:
- Escalation or prolonged disruption linked to the Strait of Hormuz could sustain higher energy costs and broader commodity price pressures, impacting manufacturing and input-sensitive sectors.
- Ongoing geopolitical tensions in the Middle East could rekindle market volatility and potentially push Japanese indexes below recent lows, affecting investor sentiment and foreign participation.