TOKYO -- Japanese stocks have been sluggish since the start of this year, but the conditions are steadily improving for the market to perk up, perhaps even significantly.
"The Bank of Japan's quantitative and qualitative monetary easing moves, including the realization of negative real interest rates, have turned out OK so far. Stock prices would have been much higher if there had not been a consumption tax hike," said Takashi Kamiya, chief economist at T&D Asset Management.
Kamiya says he is paying attention to the fact that the central bank has been steadily supplying more money to the market.
When the BOJ launched its quantitative and qualitative monetary easing program in April last year, many market players had reservations. They were afraid that as long as private funding demand was weak, money supplied by the BOJ would just pile up at financial institutions rather than flow into the market, and thus have little impact on the real economy.
Excess reserves -- the amount of current account deposits held by private banks at the BOJ in excess of the reserve requirement mandated by the central bank -- rose 120% to 112 trillion yen ($1.09 trillion) over the year through this April.
But that has been changing recently. The April growth rate (12-month moving average) of the revised monetary base -- the sum of private banks' reserves plus notes and coins in circulation, minus excess reserves -- was up 7.7% from a year earlier and up 0.9 percentage point on the month. It was the fastest growth since March 2004. It shows that although excess reserve deposits are increasing, the money is in circulation and economic activity is being stimulated at the same time.
In the U.S., growth in the revised monetary base accelerated after the launch of the first quantitative easing (QE1) in December 2008 and the launch of QE2 in November 2010. That has raised inflationary expectations and pushed down real interest rates, thereby encouraging consumption and investment, lifting stocks there in the process. Japan has had negative real interest rates, in which nominal interest rates fall below the inflation rate, since last summer.
Reasons for hope
Japanese stocks have been lackluster even though conditions for a U.S.-style economic recovery are emerging in Japan. To blame is widespread skepticism about the sustainability of an economic expansion. Goldman Sachs, for instance, expects growth in Japan's national consumer price index, excluding fresh food, to slow from 1.2% in the April-June period of 2014 -- excluding the effects of the sales tax hike -- to 1.0% in the July-September period, 0.8% in the October-December period and 0.7% in January-March 2015. The company expects Japan's national CPI to gradually deviate from the BOJ's projection of 1.3% growth for fiscal 2014.
Not all scenarios are gloomy. The stock market may break out of its funk and return to an upward trend after June. The market may get a lift from a series of important events through mid-July. These include the release of the May Economy Watchers Survey; the formulation of the government's growth strategy, which will likely contain a reduction in the corporate tax rate and reforms to the new Government Pension Investment Fund, and a BOJ monetary policy meeting to make an interim appraisal of its Outlook for Economic Activity and Prices.
Additional monetary easing by the central bank would be good for stocks. But if the effective corporate tax rate is lowered to 25% from 35%, earnings per share will rise by 15%. "The May Economy Watchers Survey will show that the effect of the consumption tax hike has been minor, as far as individual consumption behavior and corporate advertising activity are concerned," said Akiyoshi Takumori, chief economist at Sumitomo Mitsui Asset Management. If the CPI inflation rate falls below 1% as envisioned by Goldman Sachs, it is highly likely the BOJ will move to additional monetary easing.
Bearish but not broken
That said, risk scenarios remain, including a rapid appreciation of the yen in Europe caused by monetary easing, a failure of the nation's growth strategy, and a recurrence of what happened in 1997, when the economy faltered due to a sales tax hike and the Asian economic crisis.
The prevailing view is that market sentiment is slightly bearish, which is setting the stage for a shift in investment money once stock prices fall. It may sound paradoxical, but if Japanese stocks decline further due to a weakening of U.S. stocks and an appreciation of the yen beyond 100 against the dollar, these standby funds may be used for bargain hunting. A slight bearishness among investors is not expected to seriously threaten the Japanese economic recovery and uptrend in corporate earnings.
If the Nikkei Stock Average were a single stock, its expected price-to-earnings ratio would be 13.5. Chisato Haganuma, chief strategist at Mitsubishi UFJ Morgan Stanley Securities, said, "Although there is no previous data on profit forecasts, (my sense is that) the price-to-earnings ratio of Japanese stocks has fallen below that of European stocks for the first time since the 1980s. Stock prices will pick up within two months at the latest."