Global equity markets, including the US, saw a sharp decline in early August, with Japanese stocks leading the sell-off.

One of the reasons for the correction, according to Nomura strategists, was “that many market participants had the impression that stocks had risen too quickly.”

“A sharp decline in stock prices, or most other assets, causes a significant number of investors to question the validity of those prices,” they wrote. “When that happens and something unexpected happens, everyone rushes for the exits, causing asset prices to crash.”

While the recent weak US jobs report was cited as the trigger for the stock price declines, strategists stress that employment continued to increase despite the data falling short of market expectations.

In Japan, the Japanese central bank increased interest rates by only 15 basis points, so that the key interest rate fell from about 0.0-0.10 percent to around 0.25 percent.

In contrast, the Federal Reserve raised the US benchmark interest rate significantly from around 0% to 5.25-5.50% in the 16 months to the end of July 2023 and then kept it at that level for an extended period. Despite this aggressive tightening, US stock prices rose steadily from October 2022 to mid-July 2024.

“A 500 basis point hike in the policy rate in such a short period of time would normally cause funds that had flowed into equities to be shifted into bank deposits or the bond market, with a corresponding impact on stock prices,” Nomura’s team noted.

“But that didn’t happen,” they added.

Nomura also points to the role of massive liquidity injections under quantitative easing (QE), which may have mitigated the impact of monetary tightening.

The financial institutions that received these funds had to invest them somewhere, and some likely bought bonds, which helped keep yields low and in turn supported higher stock prices. This created a backdrop in which stock prices were able to rise steadily despite high policy rates, further fuelling some investors’ fears that the market was overheating.

As the market sensed signs of a slowdown in the U.S. economy and talked about a normalization of monetary policy by other central banks, especially the Bank of Japan, investors who were already skeptical of high equity valuations may have quickly retreated, thereby exacerbating the decline.