Nikkei Plunges 6.35% Overnight Into Bear Market

The Japanese Nikkei Index plunged over 6 percent overnight into bear market territory as the yen strengthened to recent highs against the dollar. The effects spilled over to other markets as European shares slipped and U.S. equity futures traded lower.

Unwinding Positions
Japan's Chief Cabinet Secretary Suga spoke overnight, and attributed the recent drop in Japanese stocks to profit taking. He said that Kuroda briefed Abe's cabinet recently, saying that profit taking following the massive run up is responsible for the drop in stocks recently.

Analysts have seen other moves. The Nikkei rose as the USD/JPY rose, or the yen devalued. However, the recent strengthening of the yen coupled with the drop in U.S. equities has seen the unwind of the carry trade and thus an unwind of these positions.

Bear Market
The Nikkei has now fallen 20.36 percent from its closing high of 15,627.26 on May 22 to Thursday's close of 12,445.38. A drop of over 20 percent is considered a bear market, and that is now where the Nikkei is on a closing basis.

On an intraday basis, the Nikkei made a high of 15,942.60 on May 22 and dropped as low as 12,415.85 overnight. Thus, on a peak to trough basis, the Nikkei has actually shed 22.12 percent.

Correction
Recall that the Nikkei nearly doubled from its 52-week low back in August to its 52-week high reached in May. Over the period, the Nikkei rose 91.43 percent, an astonishing run that seemingly went in a straight-line. At its peak, the Nikkei was up nearly 50 percent in 2013 alone.

As the attached chart shows, the Nikkei just broke below its 100-day moving average after already breaking below its 50-day moving average earlier in June. The breakdown below the major technical level was the catalyst for the sell-off, which accelerated following the breakdown.

Yen Gains
The USD/JPY made new lows overnight as well, breaking briefly below the 94 level before rebounding. The USD/JPY made a fresh cycle low of 93.784 after peaking above 103 back in May. The currency pair is still up nearly 22 percent from its 52-week low of 77.13, a move that would still be considered large by currency standards. At its high, the yen had weakened 34.5 percent against the dollar which is an amazing move, considering the economic effects of such a move.

Consider, the currency devaluation will have a profound effect on both exporters and importers. Companies who rely on foreign demand will see a boost to exports while importers will see a drop in demand as foreign goods appear more expensive. This will have derivative effects as port companies, shipping companies, and companies all over the world have to adjust and plan. And there is also the financial affects of currency hedges on income statements that will flow through over the next several months.

One company to watch is Citigroup (C). Bloomberg reported earlier this week that Citi faces up to a $7 billion loss on the yen currently. The company earned just over $8 billion over the past twelve months, so this would effectively wipe out income from every one of its many businesses.

BY Matthew Kanterman