What's the future of Japanese bank stocks after a three-day plunge of 26.5%?

Japanese bank stocks have risen 9% since the beginning of this year, but experienced massive sell-offs and plummeting stock prices last week. Despite this setback, some analysts believe that bank stocks in the Japanese stock market are relatively resilient and likely to rebound.

The plummeting of Japanese bank stocks has been influenced by the decrease in US Treasury yields, which has overwhelmed the impact of a potential interest rate hike by the Bank of Japan.

In the first three trading days of August, the TOPIX Banks index fell 26.5%, far exceeding the 20.3% decline of the TOPIX index. Both indexes experienced the largest three-day decline in at least 40 years.

The poor performance of Japanese bank stocks is somewhat unusual: the key trigger for this sell-off is the market's concern that the Bank of Japan may continue to raise interest rates after the hike on July 31, but higher rates are actually beneficial to bank profits.

Investors originally expected higher interest rates to boost bank stocks, but concerns about the possibility of a US recession in the market have overwhelmed the impact of the Bank of Japan's interest rate hike and caused Japanese government bond yields to fall, ultimately dragging down Japanese bank stocks.

Yoshitaka Suda, a cross-asset strategist at Nomura Securities, pointed out that short selling Japanese government bonds and buying Japanese bank stocks was once one of the most crowded trades among hedge funds. This time, the Japanese bank stock crash led to massive unwinding of these trades. As investors are eager to close their positions, they dumped bank stocks as a quick way out of the trades, leading to the decline in bank stocks.

Bank stocks are expected to recover.

Although Japanese bank stocks have experienced a rare and massive decline in the past few decades, the outlook for the future remains optimistic.

Yoshitaka Suda believes that high dividend yields are bullish for bank stocks, saying:

"I don’t think bank stocks will continue to be sold off. Hedge funds have lightened up their positions in bank stocks. Considering the appeal of bank stock dividends, they may be relatively resilient in the Japanese stock market."

In addition, bank stocks have an additional advantage for investors who are concerned that the yen may appreciate further, as they have limited sensitivity to foreign exchange fluctuations compared to stocks that are more vulnerable to exchange rate risks such as auto manufacturers and trading companies.

Even after the Japanese currency hit a seven-month high of 141.70 against the US dollar, the Japanese currency remains volatile.

Bank of Japan Governor Haruhiko Kuroda said in a speech on July 31st, "As long as the economy develops as forecasted, the Bank will continue to adjust its interest rates." He also urged investors to be prepared for the possibility of further rate hikes, saying that the 0.5% rate was not a particular obstacle. This shocked investors, as the market had originally expected no further adjustments to interest rates after the Bank raised the rate to 0.25% this year.

Strategists at BNP Paribas said that they favored banks over auto manufacturers, betting that banks would gain higher interest income.