📝 Recommend Selling NKY Futures As China Proxy Hedge: J.P. Morgan

The risk-off move in Japan equities remains in force today (August 18). The Nikkei 225 is so far narrowly holding at around 31,500, but near-term indications are unfavorable. While our near-term trading strategy— which has certain names on course for continued seasonal and localized return reversal through around August 25—is unaffected for now, since (1) softening supply-demand is being led by the futures market with a view to worsening conditions overseas and (2) supply-demand in the cash market conversely remains firm (= no momentum crash), we think caution is warranted around risk of acceleration or anomalies in the pace of erosion overseas.

Recent NKY futures flows show conspicuous trading as a proxy hedge for Chinese stocks. Assuming the selloff in Chinese stocks continues, we think the Nikkei 225 could get caught up in this in an uncontrolled decline to the technical breakpoint at NKY= ~30,800. We see this in turn triggering compulsory unwinding of long positions by trend- following CTAs. The second is trends in global credit markets amid unease over China and rising overseas yields. Credit markets have been quiet since April, but renewed unrest here could have a wide range of Japanese stocks facing disorderly selling pressure. This could then drive a uniform rise in correlations between individual stocks, rendering various long-short strategies and risk-controlled diversification strategies less effective and inducing risk reduction that could rapidly erode cash equity supply-demand. For now, we keep monitoring whether Japanese equities are being overly affected by the risk-off mood from overseas. - J.P. Morgan Strategy