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The Globe and Mail

Nikkei’s nosedive: Blame it on optimism

A pedestrian passes an electronic stock board of a securities firm in Tokyo showing Japan’s benchmark Nikkei 225 stock index, centre top, that gained 272.34 points to 12,634.54 after the central bank announced more monetary easing.

Koji Sasahara/AP

Despite the Nikkei 225's lofty climb in recent months, the 7.3 per cent decline in overnight trading on Thursday has observers scratching their heads.

You can look at the latest reading on China's weakening economy or the debate the stick-to-it nature of the Bank of Japan's stimulus policies – but surely global markets have been building up some froth in recent months.

The last time Japan's benchmark index fell this sharply was in 2011, when Japan was hit by a devastating earthquake and tsunami, which sent the Nikkei tumbling 10.6 per cent. Before that, you have to go back all the way to 1987, when it fell 14.9 per cent.

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Thursday's decline follows numerous signs of rising optimism among investors – which, in a contrarian way, can often spell trouble ahead. According to the Financial Times, individual investors in Japan had been showing increasing interest in stocks, with their share of trading rising to a record 35 per cent last week, no doubt driven by the Nikkei's 80 per cent rally since November.

Closer to home, investors have also been embracing stocks more closely. The latest weekly sentiment reading from the American Association of Individual Investors surged to nearly 50 per cent last week, close to its highest reading of the year and an increase of 10 percentage points over the previous week.

Strategists have also been pounding the table in favour of stocks. This week, Goldman Sachs raised its year-end target on the S&P 500 to 1750, up from 1625. It also argued that the bull market would drive the U.S. benchmark index to 2100 by the end of 2015.

This isn't to say that the bullish impulse is misplaced. But it does suggest that disappointment is going to hurt.

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