JPMorgan watches for stock-specific risks to spread across the market after Nikkei rebound

How much has selling pressure eased after the Nikkei’s rebound?

At midday Tokyo time on 27 October, the Nikkei held 62,000 and rebounded to 63,300. Easing strains in the French government bond market and a filing for an IPO by US AI startup Anthropic helped improve market sentiment.
JPMorgan estimates that trend-following traders (CTAs) have cleared the Nikkei futures long positions accumulated since the end of September. If the index stays between 63,000 and 65,000 over the next two to three trading days, the bank believes further position-closing pressure could subside, technically confirming a short-term bottom.
Flows in the cash market are more complex, but the bank estimates that the net Japanese equity exposure of hedge funds using momentum strategies has returned to its median over the past decade, reducing the likelihood of excessive position unwinding. Meanwhile, the rebound in AI stocks may simply reflect intraday traders covering shorts, and market sentiment toward AI remains cautious.

JPMorgan views the market move in October, led lower by AI stocks, as a temporary correction: as the economic surprise index weakened, macro hedge funds and CTAs partially reduced equity longs and bond shorts, amplifying the risk-off trade.
The bank believes the decline in risk assets has lowered market expectations, making it easier for actual economic and earnings performance to exceed expectations before year-end. If the historical pattern of recovering expectations and rising risk appetite repeats, the Nikkei’s low in this cycle could be around 62,000.
Under this scenario, the bank expects CTAs to rebuild futures long positions starting in November and attract speculative capital targeting 70,000 by year-end. However, global high-yield bond spreads have yet to stabilize after widening, and developments in Europe and the performance of some US AI companies could intensify financial stress.

Cybersecurity-related news has risen noticeably in Japan and overseas, with the volume of Japanese reporting reaching a record high. JPMorgan is focused on the possibility that such incidents could expand from problems at individual companies into concerns about the cost of using generative AI and regulatory risks.
Cybersecurity news currently accounts for only a few percent of global stock-market coverage. By comparison, in 2020, when the share of coverage about infectious diseases rose to 5% to 10%, a risk previously seen as local came to affect the entire market; the bank regards cybersecurity coverage exceeding approximately 5% as a warning signal.
Since June this year, increased cybersecurity coverage has coincided with falling generative AI token prices, but the causal relationship between the two remains unclear.

Recently, the effectiveness of long-short momentum strategies in developed markets has disappeared on both sides, with performance weakening for both long and short positions, resembling the position adjustments before the pandemic was declared in 2020. After the declaration, broad selling caused longs to continue underperforming, while profits on shorts supported strategy performance.
At the start of 2020, CTAs first reduced Nikkei futures longs, then bought again in February, before rapidly switching to shorts around the pandemic declaration. CTAs have now cleared recently established Nikkei longs and may resume buying afterward; however, their Chinese equity futures positions may also be turning net short, similar to the situation then.