Is Japan's stock market rally for real?
The Bank of Japan helped push equities to 26-year highs, but exit strategy questions remain
MASAYUKI YUDA, Nikkei staff writer
TOKYO -- Charles Gave has earned a reputation for making bold investment calls during his 40-plus years working in finance. But for the last quarter century, the legendary French investor has wisely avoided making a bold call on Japan, choosing instead to sit out each of the five short-lived rallies that the Nikkei 225 index has staged since the investment bubble burst in the early 1990s.
He began to rethink his long-held position this year, however, after seeing signs of a strong rebound in Japan's private sector. For the first time since 1991, he became confident that Japan was entering a self-sustaining recovery.
"I am decisively bullish on the Japanese equity market," Gave told the Nikkei Asian Review this month. "I will remain invested as long as the [positive signs] remain in place."
Gave, chairman of Hong Kong-based research company Gavekal, isn't the only foreign investor to return to the Japanese equity market after a long absence. On Nov. 7, the 225-issue Nikkei Stock Average, Japan's benchmark equity index, reached a 26-year high, with money from overseas being a key driver.
Japanese stocks have been on a hot streak, with the Nikkei rising by as much as 20% this year, outperforming the S&P 500 index, the FTSE 100 and the DAX. In October, the Nikkei enjoyed its longest winning streak in history, with 16 consecutive days of advances. It has given up some of those gains in recent days, but is still up 17%.
This performance, as strong as it has been, leaves the Nikkei 225 only halfway back to its 1989 bubble peak of 38,915. But Japanese stocks have managed to breach another psychological barrier -- the 1,800 mark on the broader Topix index, a level known by some investors as "the iron coffin lid." Investors have come close to pushing the lid open during periodic rallies over the years, but it never lifted until this month.
This has left investors around the world asking the same question: Is Japan's rally for real this time?
There are reasons for optimism. The Japanese economy has grown for 58 consecutive months, its second-longest postwar expansion. A weaker yen has boosted exports. Corporate profits are at record levels, and some investors were cheered by the decisive re-election of Prime Minister Shinzo Abe and the coalition led by his Liberal Democratic Party in last month's election.
"In Japan, there are Abe fans and haters," said Yoshihiro Ito, chief strategist at Okasan Online Securities. "But from foreign investors' point of view, Abe's victory means political stability. In an uncertain world, that's a great reason for them to buy Japanese equities."
Yet in Tokyo, there is a palpable lack of market mania. Decades of hard experience have left many market veterans cautious about predicting a full-fledged bull market for Japanese stocks.
One potential obstacle to a sustained rally is time. Japan is just now joining a party that has been in full swing for a while, as a synchronized economic upturn has boosted growth and stock prices around the world. Asian markets have been experiencing a broad rally in equities, including India's Sensex and Hong Kong's Hang Seng. The U.S. stock market is in the midst of its second-longest bull market in its history. Emerging markets have been rebounding strongly, and even Europe has been attracting bargain-hunting investors.
"We are at the very late stage of a long bull run," said Mustafa Sagun, chief investment officer at Principal Global Equities. "I don't expect the end to come very soon, but we need to closely monitor what happens next."
Another obstacle could be the trustworthiness of the stock prices themselves. The Bank of Japan has only strengthened its ultra-easy monetary policies since the introduction of Abenomics in 2012. The most controversial of these -- even within the BOJ -- has been its purchase of exchange-traded funds, or ETFs.
The central bank has been buying trillions of yen worth of these securities, which track the Nikkei or Topix index, and plans to spend 6 trillion yen ($52.9 billion) annually. Since the program began in 2010, it has purchased over 16 trillion yen of ETFs. These purchases have made the BOJ a large shareholder of index constituents such as Fast Retailing, the company that owns Uniqlo, and electronics components company TDK.
For companies with relatively few shares in circulation, having the BOJ as a major shareholder can have a dramatic effect.
"The pricing of companies with proportionally low free float is being severely distorted by the BOJ," said Shingo Ide, chief financial engineer at NLI Research Institute.
The recent rally has only intensified questions about when and how the central bank intends to wind down these programs. "The BOJ, so far, has presented no exit strategy," said Robert Feldman, senior adviser at Morgan Stanley MUFG Securities. "I think it's a good time for them to come up with one on ETF purchases."
When Japan's long bear market started more than a quarter-century ago, it had the advantage of being the only developed economy in Asia. For international investors, owning Asian stocks was synonymous with owning shares in Japanese companies. That's why the investment community still uses the classification "Asia ex-Japan" -- a description that seems outdated given the massive changes in the region, led by China.
When the Nikkei average hit its peak on the final trading day of 1989, the value of the Japanese market was $4.26 trillion. In contrast, Hong Kong -- which has now displaced Tokyo as the region's financial hub -- was $77.56 billion, a mere 1.8% of Japan, according to the World Federation of Exchanges. Mainland China did not even have a stock market. And South Korea and Taiwan did not allow foreign investors to directly buy their domestic shares.
What happened next is seared into the Japanese psyche. The investment bubble collapsed in the early 1990s, with stock and property prices cratering. Banks, securities companies and investment houses collapsed or were forced into compulsory takeovers, including the spectacular failure of Yamaichi Securities in 1997. The resulting "lost years" of deflation and low growth drew attention to poor corporate governance at Japanese companies -- all issues that the country still faces today.
As Japan struggled, stock markets across Asia began to open up. Emerging economies like the Philippines and Indonesia gained investment-grade status from rating agencies, leading investors to shift money away from Japan and spread it across the region. And investment poured into China, which was taking its first steps toward economic liberalization during Japan's bubble years but is now the second-largest economy in the world.
This remarkable shift led to the emergence of corporate powerhouses across Asia that in some cases have eclipsed Japan's leading companies. South Korea's Samsung Electronics, the semiconductor and smartphone giant, has attracted a market value of 401.56 trillion won ($359 billion) -- well above that of Japan's most valuable company, Toyota Motor, at 23.27 trillion yen ($205 billion).
Taiwan Semiconductor Manufacturing Co. was not listed in 1991, but has now become the world's largest contract chipmaker, with a market value roughly the same as Toyota's. And in China, technology groups Tencent Holdings and Alibaba Group Holding have achieved market values of roughly $470 billion, drawing comparisons to Google or Amazon.com.
Subaru President and CEO Yasuyuki Yoshinaga apologizes for the carmaker's illegal inspection practices, in Tokyo on Oct. 27. Despite a spate of high-profile scandals, some say corporate governance in Japan is improving. © Reuters
In Japan, however, recent headlines have been dominated not by stories of innovative, fast-growing new companies but by questions about the very nature of how it does business. Scandals at some of its leading companies -- from faulty inspections at Nissan Motor to Kobe Steel's fake data about its products -- have soiled the reputation of Japan Inc.
But this narrative shortchanges Japan's strengths in robotics, artificial intelligence and its manufacturing prowess in leading-edge fields such as electric car components. The market cap of Nidec, which manufactures electric motors, has increased 74 times since the last market peak of 26 years ago, catching the same tech wave as some of its Asian rivals. Keyence, which produces sensors essential for factory automation, has grown 24-fold in the same period. The robot maker Fanuc has quintupled.
And even though its neighbors are growing more quickly, some specialists see pluses in Japan's equity market. "Compared to other Asian markets, Japan is far more liquid and transparent," said Douglas Butcher, a senior adviser at BNP Paribas Securities (Japan).
Some say there has been a shift in corporate governance in Japan, despite the spate of high-profile scandals. Seth Fischer, chief investment officer of Hong Kong-based hedge fund Oasis Management, said he has seen "dramatic improvement" since Japan introduced a new corporate governance code in 2015.
"I have been investing in Japan for the past 23 years. I think the biggest change, I bet, is in the last two years," Fischer told the Nikkei Asian Review this month, noting that there are more independent directors in Japanese companies now. "That's a big step. In many cases disclosure has gotten better," he said, adding that shareholder payments in terms of buybacks and dividends have noticeably increased.
Money pouches and eel
As Japan's stocks were surging to highs not seen in decades, Norihiro Fujito, a senior strategist at Mitsubishi UFJ Morgan Stanley Securities, reminisced about the boom years in Kabutocho, Tokyo's financial district.
In those days, brokers knew that big spikes in the Nikkei would be rewarded with a pouch containing bonus money. Cash in hand, they would head out for a celebratory dinner. Rice bowls with eel on top was their favorite, as they hoped stock prices would rise again like eels ascending a stream.
The cheerless nature of the recent rally may be due to a lack of retail investors, who have been net sellers throughout the rise.
"Some investors may be consolidating profit by selling stocks they held on to for over 20 or 30 years, now that those are finally back at a profitable level," said Okasan's Ito.
Fujito offered a slightly different analysis. "Retail investors are waiting for a large correction, which will be a good opportunity for them to buy equities," he said. "But there have been no such dips because of enormous passive investment -- including the BOJ's ETF purchases."
After decades of stagnation, Japanese households are wary of investment. Almost 52% of their financial assets are held in cash, often stored in safes, or in bank deposits.
Masakazu Yanagisawa, equity sales director at Deutsche Securities Japan, characterized the market's mood as "less cheerful than when Abenomics started." However, he believes that "if the rally goes on for another one or two months, the mood will turn far more positive."
That kind of sustained rally could also raise pressure on the BOJ to begin unwinding its ETF-purchase programs. The recent sharp run-up deprived the central bank of good buying opportunities; in October, the bank bought just shy of 150 billion yen worth of ETFs. To reach its annual 6 trillion yen target, it needs to buy 500 billion yen worth per month on average.
BOJ Gov. Haruhiko Kuroda, however, hinted that the current policy has room for some flexibility. "The BOJ's guidelines for asset purchases suggest the bank will buy ETFs so that their amount outstanding will increase at about 6 trillion yen -- it's a wide expression," said Kuroda, putting emphasis on the word "about" at the press conference right after the policymaking meeting on Oct. 31.
International Monetary Fund Managing Director Christine Lagarde sent a message to policymakers around the world to "fix the roof while the sun is still shining," in a recent interview with Nikkei Asian Review, suggesting that central bankers should begin withdrawing emergency economic stimulus policies implemented in the wake of the global financial crisis.
Certainly the sun is up, or at least rising, in large part thanks to the efforts of the BOJ, noted Morgan Stanley MUFG's Feldman.
"The presence of the BOJ has helped investors to gain back confidence in Japan's equity market," he said.
This, in turn, means the central bank could disappoint the markets by withdrawing its support. With his term's end approaching in April 2018, Kuroda would rather quietly taper than bluntly announce the shrinkage or termination of the purchasing program, which could lead to a big shock to the market.
If the market keeps rallying free from the BOJ's supportive push, then investors can finally say Japan's market is back "for real" -- for real.
Additional reporting by Joyce Ho in Hong Kong and Kenji Kawase, Takahito Fujiwara and Mitsuru Obe in Tokyo