Original author: Zhao Ying

Original source: Wall Street Observer

Will the Japanese stock market repeat the crash of August 2024?

The global investors have not forgotten the crash from two years ago. From July to August 2024, the TOPIX dropped 24% from its historical peak, triggered by the rapid depreciation of the US dollar against the yen from 162 yen to 143 yen in less than a month, compounded by the Bank of Japan's unexpected interest rate hike and the US non-farm data coming in weaker than expected. A combination of multiple negative factors ignited a market heavily tilted towards exporters and financial stocks, plunging it to rock bottom. With the yen continuing to weaken today, market concerns have returned.

According to the trend trading desk, Goldman Sachs' Japanese equity strategy analyst Bruce Kirk pointed out that the current macro environment facing the yen is fundamentally different from two years ago, and the conditions that triggered the yen's rapid appreciation have clearly weakened; however, the level of positioning in the stock market, whether in terms of the scale of net buying by foreign investors, hedge fund allocation ratios, or retail investor margin balances, has exceeded or significantly surpassed the levels of July 2024 . The probability of a currency flash crash has decreased, but if there is an unexpected shock in the AI narrative or geopolitical events, the fragility of the Japanese stock market could be even higher than two years ago.

The core of this judgment is: if the risk comes from the yen, the issue has never been the starting and ending points of the exchange rate, but rather the speed of change. From January to March 2025, the dollar depreciated from 158 yen to 147 yen gradually, while the TOPIX actually increased by 5% during the same period. The crash in July 2024, however, was exactly triggered by the yen rapidly strengthening by 11% in just three weeks. Currently, the market has almost no pricing for a sudden strengthening of the yen—implied volatility for the dollar-yen exchange rate over 1 month is relatively low—so if an unexpected event occurs, the impact will be greater.

The true mechanism of the 2024 crash: not the exchange rate, but the triggering of stop-loss chains

Restoring the internal logic of that crash is much more complex than the superficial explanation of "the yen's appreciation suppresses exporters' profits".

Stage One (July 11 to the end of the month): Unexpectedly lower US CPI and yen interventions led to a decline in exporter-related sectors first. The TOPIX banking index barely moved during this period, even rising 5% on July 31, the day the Bank of Japan announced its interest rate hike.

Stage Two (July 31 to August 5) was the real slaughter. The hawkish degree of the Bank of Japan's interest rate hike exceeded expectations, followed by tumbling US non-farm data on August 2, resulting in two independent negative narratives converging within 48 hours. Bank stocks plummeted 27% from the peak on the interest rate hike day to August 5, and the implicit bias in the overall market positioning—long positions in exporters and financial stocks, short positions in domestic defensive stocks—was completely reversed.

Hedge funds typically set their drawdown limits at around -2.5% of the capital deployed. In such a market environment, a market-neutral portfolio with a net exposure that appears not high but has a 5% sector bias could see losses of about -5% from peak to trough, enough to trigger stop-loss limits. Stop-loss triggered → positions forcibly liquidated → long funds forced to sell → risk parity and CTA funds perceiving momentum reversal join the sell-off, creating a complete negative feedback chain.

Eventually, after the August 5 crash, the TOPIX rebounded 23% from its low by September 3. The speed of the rebound itself indicates a problem: this is more a liquidity crisis triggered by stop-losses, rather than a repricing of the fundamentals of the Japanese stock market.

The logic of maintaining a weak yen is more solid than in 2024

The set of “perfect storms” that suddenly turned the yen two years ago—higher-than-expected interest rate cut expectations from the Federal Reserve, the Bank of Japan's unexpectedly hawkish rate hike, and yen interventions—currently does not have the conditions to occur simultaneously.

The logic driving the current weakness of the yen has switched. Before 2024, the real interest rate differential between the US and Japan could explain the dollar-yen trends well. However, since the defeat of the Liberal Democratic Party in the Japanese Senate elections in the second half of 2025 and the rise of the political regime led by Sanae Takachi, the market has begun to have doubts about Japan's fiscal sustainability—economic stimulus has pushed up JGB yields, but this upward movement reflects more the continued expansion of Japan's government debt term premium relative to US bonds, rather than a narrowing of the US-Japan interest rate spread. The 10-year Japanese government bond yield has approached 3%, raising discussions about the outflow of Japanese pension assets, but mainstream judgments believe that if this process is gradual and well-anticipated, it is unlikely to trigger a crash like that of 2024.

Goldman Sachs' G10 foreign exchange strategy team has raised their 3-month, 6-month, and 12-month forecasts for the dollar against the yen to 162, 163, and 165 respectively (previously 160, 158, and 155), citing "higher and longer US rates, low risks of recession, concerns over Japan's fiscal situation, and the very slow rate hike path of the Bank of Japan, all supporting continued depreciation pressure on the yen".

From CFTC holdings data, the net short position of non-commercial speculators in the yen has approached the levels seen in July 2024. However, the difference this time is that the market itself has already priced in the weakness of the yen—whereas the crash in July 2024 occurred precisely because the market had not priced in the sudden strengthening of the yen at all.

Japanese stock positions are more crowded than two years ago, with a higher concentration

Macroeconomic factors are favorable for maintaining a weak yen, but vulnerabilities in the stock market have been quietly accumulating.

In terms of quantity: The TOPIX and Nikkei 225 are up 37% and 53% respectively compared to July 11, 2024. Foreign net purchases have seen net inflows of about 14.8 trillion yen since the Liberation Day in April 2025, and currently, foreign net positions are over 20% higher than before the crash in July 2024. Retail financing balances (margin purchase balances) are 35% higher than in July 2024, approaching five-year highs. Goldman Sachs' prime services data shows that hedge funds’ total/net allocations to Japan are at the 99th and 98th percentiles, respectively, in the past five years.

Structurally: The increase in the TOPIX this year has been highly concentrated—many constituent stocks remain below their 200-day moving average, but the index has been driven higher by banks, steel, non-ferrous metals, electronic/precision instruments, and AI-related exporters. The Nikkei/TOPIX ratio (NT ratio) expanded to 18 times historical highs in June of this year, and the median valuation of AI-related stocks in the TOPIX is nearly double that of non-AI stocks. This is similar to the structure before the crash in July 2024: a large number of portfolios imply a long position in exporters and financials, and a short position in domestic defensive stocks.

In the event of an unexpected shock, this structure means that sell-off will quickly propagate, and it will be challenging to hedge in a timely manner.

The real tail risk: the collapse of the AI narrative or geopolitical black swan

The probability of a flash crash triggered by the yen is lower than in 2024. A more concerning risk comes from another direction: any event that shakes the global AI growth narrative—similar to the selling triggered by DeepSeek in the first quarter of 2025—or a geopolitical shock significant enough to impact the narrative of "the US-led global economic growth stability" could put the currently crowded AI-related positions in a situation comparable to the exporters' positions in 2024.

The crash two years ago was characterized by many overseas investors as a “Japan-specific problem”. However, at this moment, the Japanese stock market carries a highly concentrated expression of the global AI theme, with both foreign and retail investor positions at historical highs. If the narrative reverses, the issues of exporting may not just be a problem for Japan.

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