Nikkei 16% October Bump at Risk After Wednesday Crash

The premier Japanese equity index has slipped in November amid global concern around AI tech stock valuations. Is it a correction after gaining 16% in October or the beginning of a new trend?

The Key Developments

• The Nikkei 225 gained 16% in October thanks to growing optimism in the AI space, with Japanese tech firms leading gains.
• Following the release of major global AI companies' earnings reports, traders began to worry about sky-high valuations, with even the Japanese government expressing concerns.
• The hawkish stance of the BOJ, which could raise rates in December, could put further downward pressure on the Nikkei.

Record Highs on Tech, Stimulus

The Nikkei 225 roared 16% higher in October amid the election of a new Prime Minister and following a trade deal with the US. Tech stocks even more heavily weight the index than the Nasdaq in the US, including major manufacturers of components needed to build out AI infrastructure. Additionally, the elected Prime Minister promised to increase government spending to boost the economy. So, it's not surprising that the index rose through October as investors anticipated a strong showing from the major AI leaders. Stocks that led gains through the month include Socionext, Avantest, and Hitachi. However, by the end of the month, most of the top tech firms had already reported earnings, with just Nvidia left of the "Magnificent 7", leaving investors waiting for more news. This allowed traders to take a look around and start worrying about valuations after the Nikkei broke highs set forty years ago amid another bubble.

Starting in November, the Nikkei has been trading lower, with analysts speculating that this is largely due to profit-taking following the strong gains seen the previous month. It didn't help, however, that Japan's Vice Minister of Finance and top FX diplomat, Atsushi Mimura, came out on Wednesday toexpress concern over the rapid growth in AI stocks. He usually speaks for the Ministry of Finance when it wants to stabilise the currency, so his comments on equities were influential. The Nikkei dropped 4.1% on Wednesday, led primarily by companies in the tech sector. Softbank, one of the biggest Japanese firms backing the AI space, saw its shares decline by as much as 14%.

A Correction or Fading Tailwinds?

It may be a matter ofunfortunate timing for the Nikkei, as the effect of the stimulus announcements from Prime Minister Sanae Takaichi starts to fade at the same time investors are worried about tech stock valuations. Major global indices started Friday on the back foot, showing that concern over the future of AI extends beyond Japan. However, unlike Europe and the US, Japanese stocks face a central bank inclined towards hawkishness. Last week, BOJ Governor Kazuo Ueda gave remarks that hinted at an imminent rate hike, which could come as soon as December. Also last week, the Tokyo CPI came in at 2.8%, above the anticipated 2.4%, suggesting that consumer prices remain a problem and could motivate the BOJ to continue tightening. This may put further downward pressure on Japanese stocks through the rest of the year.

Nikkei in Overbought Zone But Still Holding Line

The long-term view on the Japan 225 weekly chart shows some sort of parabolic move, with RSI in the overbought zone, current price above the trendline connecting prior record highs and far from the previous range-bound top at 42500. However, the measured-move projections suggest a peak near 54500, which signals a potential short-term upside if bulls can maintain 50k and 49k. Crossing back under the trendline would expose 45k and the prior record peak of 42500. Holding firm, however, could lead to unexplored territory, bringing into focus 55k and beyond.

Source: SpreadEx | Japan 225, Weekly Chart