The SGX Nikkei 225 Index Futures contract is based on the underlying Nikkei 225 Index, the premier benchmark for Japanese equities. The three largest constituents of the index include Fast Retailing which owns Uniqlo; Tokyo Electron, a manufacturer of semiconductor production equipment for customers such as TSMC and Samsung; and Advantest Corp, a provider of semiconductor testing equipment and solutions.

The Japanese stock market has outperformed most of its developed market peers so far this year. In terms of total return, the contract is up by 13.44 per cent year to date, more than double the S&P 500’s 5.73 per cent year-to-date gain as at the market close on Apr 17. Following strong wage gains at the spring labour negotiations, the Bank of Japan hiked rates for the first time since 2007 and brought an end to their Yield Curve Control in March.

The structural drivers of the Japanese stock market include improved corporate profits, corporate governance reforms leading to higher shareholder returns, tax-free investing via the Nippon Individual Saving Account programme, and the return of healthy inflation and wage growth.

Despite a recent bout of weakness, we remain constructive on the SGX Nikkei 225 Index Futures contract and expect it to end 2024 between the 61.8 per cent extension level near 42,500 and the 76.4 per cent extension level around 43,600. Using a Fibonacci Extension and Fibonacci Retracement drawn from the low on Jan 8, 2024, our thesis is validated if the contract sees a false breakout with a sustained close above the key psychological level of 38,000. We view the current weakness as an excellent entry opportunity, given the supportive structural drivers.

A standout feature of the Nikkei 225 Index is its relatively high exposure to AI due to its tech-heavy composition, with the technology sector accounting for 50.27 per cent. This surpasses the S&P 500’s technology weightage of 29.83 per cent. We think this positions Japan well to capitalise on AI and a potential cyclical recovery in semiconductors. The AI narrative is expected to continue serving as a tailwind for semiconductor material (photomasks, silicon wafers) and equipment makers, which are prevalent in Japan.

The consumer goods sector, accounting for 23.69 per cent and being the second largest, is expected to benefit from the return of inflation and wage growth. We anticipate a gradual shift in consumer and business consumption, investment, and savings patterns.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

Companies may shift their focus from cost management to price increases, while consumer spending may increase with higher purchasing power. From a technical perspective, the four-hourly chart shows that the contract has broken below key psychological support at the 38.2 per cent retracement level, approximately around 37,956 to 38,000. We expect to see a potential retracement above this level in a false breakout. Other key technical observations supporting our bullish thesis include the 14-day Relative Strength Index indicator which is currently in oversold territory below 30. A buy signal is usually triggered when the indicator crosses above 30 from below.

Despite intervention risks, we think it’s worth noting that the Bank of Japan views the USD/JPY rate of change as the key catalyst for intervention, rather than a specific exchange rate level.

In summary, we remain constructive on Japanese equities, as the structural growth drivers remain unchanged. We expect the SGX Nikkei 225 Index futures contract to conclude 2024 between the 61.8 per cent and 76.4 per cent extension levels. While near-term weakness may persist as risk appetite falls due to geopolitical tensions and delayed US rate cuts, we see the current pullback as an excellent entry opportunity and expect Japanese equities to outperform other developed market peers both in absolute terms and relative to their peers. For risk management, we prefer to have stop-loss slightly below the 50 per cent retracement level at around 37,000.

The writer is investment analyst at Phillip Nova