Japan's Nikkei 225 stock index tumbled 5.2% Thursday to 13,589.03, bringing the market's retreat from last week's closing high of 15,627.26 to 13%.
Despite the fall, some portfolio managers at investment management firms say they're more inclined to see a healthy correction than signs that the bull market of the past six months for Japanese stocks — sparked by the promise of far-reaching economic stimulus measures and reforms — is dead.
“This is a very rapid but healthy correction, reversing a very rapid upturn,” said John Vail, Tokyo-based chief global strategist with Nikko Asset Management.
The Nikkei 225 surged 77% between mid-November, when Shinzo Abe was en route to leading his Liberal Democratic Party to a decisive general election victory on the promise of aggressive steps to revive Japan's economy, and last week's market top.
With a gain of that magnitude, it would have been more surprising if a correction like the past week's sell-off didn't happen, shaking out some of the short-term momentum players along the way, said Dean Cashman, a Singapore-based investment director with Eastspring Investments and head of the firm's Japanese equity team.
Mr. Cashman said the rally has been a meaningful one but it started from a point “different from anything we've seen in the past,” with Japan's broad market trading below book value and years of tough market conditions, like a strong yen, that had forced many companies to get their balance sheets into fighting trim.
When the dust of the current sell-off settles, the market should remain an interesting one for investors driven by economic fundamentals, observers say.
Japanese companies are still only trading at around 1.2 times book value on forward earnings, and with the yen's recent retreat helping Japan's exporters and the operating leverage healthy balance sheets will give those companies to any upturn, the market's current retreat should throw up interesting opportunities for investors, said Mr. Cashman.
“We don't think this is the end of the bull market because valuations are still attractive,” agreed Nikko's Mr. Vail, who noted that Japan had far stronger first quarter growth than either the U.S. or Europe and will likely have superior growth in the current quarter as well.
Still, some observers concede the easiest part of Japan's return to the radar screens of global investors may be over.
“I don't think the Abe-nomics trade is over but … the first stage” driven largely by expectations, “is over,” said Stephen Halmarick, the Sydney-based head of investment markets research with Colonial First State Global Asset Management.
The monetary and fiscal policy measures Mr. Abe has talked about are important, but the structural reforms he promised to pursue — what Mr. Abe calls the “third arrow” in his policy quiver — is “probably the most important, and the most difficult,” said Mr. Halmarick.
Being able to evaluate those structural reforms, and their likely impact on Japan's economic prospects, will go a long way in determining how strong this rally will be, Mr. Halmarick said, adding “what we really need to see is the implementation of those policies.”
While it has been fashionable over the past two decades to be cynical about promises of reform from Japanese political leaders, market watchers say this time may be different. Messrs. Vail and Cashman said they've been pleasantly surprised in recent months with Mr. Abe's willingness to discuss painful structural reforms ahead of a July election of Japan's upper house of parliament.
While it's early days, the indications are that Mr. Abe is looking to go “really hard on policy,” to break the cycle of disappointment in managing Japan's economy, said Mr. Halmarick.