The Japan market volatility continues, with TOPIX falling 4.8% on June 13 and now officially entering bear territory. Some market observers are linking the market’s decline to the yen’s renewed appreciation and disappointment with Japan’s growth strategy (many other theories have been suggested as well), but Chisato Haganuma, Chief Equity Strategist, Mitsubishi UFJ Morgan Stanley thinks factors outside of fundamentals may also be having a major impact. Sam Jones of The Financial Times reported on June 12 that the main Commodity Trading Advisors (CTAs) posted losses in excess of 8% in May.


What Are CTAs and how is it causing Japan market volatility?

CTA are asset managers—often set up as hedge funds—that trade in stocks, bonds, commodities, and foreign currencies, mainly utilizing futures contracts and options and other derivative instruments, based on quantitative market analysis and a fixed set of investment parameters. CTAs have become popular because of the high returns they generated even as global stock markets fell sharply in 2007-09.

Haganuma believes the correlation between the return on equities and commodities trading has strengthened since 2009 and he thinks one of the reasons for the stronger correlation between risk asset returns is the increase in CTA assets under management.

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Since 2H 2009, the Hedge Fund Research Macro/CTA index has not generated the returns manu would expect, which Haganuma attributes partly to growth in the asset base of funds using similar investment strategies. Hr believes the “trend following” investment strategy of CTAs makes it difficult to generate returns when the market is trading within a narrow range or the market trend shifts suddenly.This is likely why large price movements in global stocks and bonds have negatively impacted recent CTA performance. The unwinding of CTA positions may also exacerbate price movements.

CTAs also behind correlation between Japan Market Volatility and CDS index?

Haganuma states further that he think hedge funds are also having a considerable impact on  Japan market volatility in equities, which are likely to attract CTAs given their high liquidity and close correlation with US long-term interest rates and the dollar/yen rate. The ratio of trading value on Nikkei Average and TOPIX futures markets to spot markets has been rising sharply since 2008. Between November 2012 and May 2013, a rise in Japanese share prices has coincided with a decline in Japan’s CDS index.

According to this theory the correlation reflects the decline in credit risk of Japanese companies as a result of the BoJ’s aggressive easing and the weak yen, as well as a more positive outlook for earnings. Furthermore, many think it suggests investors are taking advantage of the correlation between share prices and credit risk. Japanese stocks have fallen sharply since May 23, as the CDS index started to rise.

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Conclusion: The recent decline in Japanese equities is likely due to not only fundamentals (economy, government policy) but also investors like CTAs looking for short-term gains. However, Japan market volatility can fuel uncertainty and pessimism about the economy and earnings leading to a negative virtuous circle.