June 6, 2017 5:10 pm JST

'Trump rally' hearkens back to 1929

One US investment manager is telling clients to hold more cash

An electronic board in central Tokyo shows the Nikkei Stock Average as well as indexes of other markets on June 2.

TOKYO -- U.S. President Donald Trump's protectionism is shaking the global political and economic orders. But the stock market continues running up as though there were no Trump risk.

Investors are in a box they don't recognize.

The Nikkei Stock Average climbed above 20,000 last week and seems poised to test 20,868, the highest point the benchmark index has reached since 2000. Tokyo stocks met with selling on Tuesday, but the Nikkei average managed to stay at the 19,900 level.

Despite the bull market, insurers and pension funds are flocking to a risk management fund created by the U.K.'s Capula Investment Management. The fund is structured to tolerate a slide of up to about 40%, so even if the Nikkei were to tumble 50%, the fund's loss would be limited to 10% or less.

When Capula first launched the fund for U.S. stocks, many Japanese institutional investors showed strong interest. So the company has created a version for Japanese stocks.

Capula is expecting the fund to attract 100 billion yen ($910 million) by the end of this year.

Unusual economic dynamics are driving the current global stock market rally, unnerving many investors. While the world economy is recovering, neither wages nor prices are on the rise. In the U.S., interest rates are refusing to pick up significantly despite the country's solid economic performance.

So stocks are rising globally.

Let's look at the situation from Japan's vantage point.

"The effects of the Bank of Japan's negative interest rate policy will start making themselves felt in an even more pronounced way in the coming months," predicts Shunichi Yamada, a managing director at Goldman Sachs Asset Management.

Yamada has estimated that 90 trillion yen worth of Japanese government bonds held by banks will mature every year.

The banks will not plow the cash they get from these bond redemptions back into Japanese government debt, which yields almost nothing. They will have no choice but to invest the money in stocks and foreign bonds.

The situation is more or less the same for pension funds. The corporate pension fund for ink maker DIC and its group companies has sold all of its Japanese government bond holdings. Instead, it is buying stocks with stable prices, shares in the stock investment risk management fund and infrastructure-related assets. The number of pension funds with no Japanese government bond holdings is rising sharply.

Financial institutions only need modestly earning investment vehicles. Pension funds have already lowered assumed yields. They look for vehicles that are not as risky as stocks and offer annual yields of around 2% to 3%.

Few such investments are available at the moment.

U.S. Treasurys are almost the only long-term government bonds issued by an industrial country with a high credit rating that offer annual yields of over 2%.

That's why risk-averse investors are piling into Treasurys, keeping interest rates in the U.S. from rising.

Since there are not enough Treasurys to absorb all the investment money out there, huge piles of cash are also flowing into stock markets.

The total amount that major U.S. companies gave back to shareholders in 2016 through stock buybacks or dividend payouts was 50% more than what they invested in facilities and equipment.

These companies are looking at the same picture: Low growth rates limit the number of good investments available, and Trump is unlikely to deliver on his promise of massive infrastructure investment any time soon.

The Economic Policy Uncertainty Index for the U.S., developed by a group of top economists, is stuck at high levels. American companies are having a hard time trying to figure out where they should invest their earnings.

While there is little doubt that gradual global economic growth is supporting equity markets, stocks have also received a big boost from the dearth of safe and decently profitable investments.

Ominously, the level of overvaluation of U.S. stocks in terms of long-term profit prospects is now approaching that before the Black Thursday crash in 1929, which triggered the Great Depression.

Pacific Investment Management Co., a U.S. firm better known as Pimco, has sounded the alarm, urging investors to increase the amount of cash they hold.

The International Monetary Fund has warned about soaring home prices in Canada.

If stocks keep creeping up while economic growth remains modest, the world economy will face a growing risk of higher interest rates shifting the current cycle into reverse with disastrous consequences.

(Nikkei)

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