A rapid plunge in Japanese stock prices is forcing investors to question whether the great bull run of the last seven months is over.
Japan’s benchmark Nikkei 225 index tumbled 7.3 per cent on Wednesday, the biggest drop since the massive earthquake and tsunami in March, 2011.
“Clearly the Nikkei had been overbought for some time,” said Colin Cieszynski, senior market analyst at CMC Markets. “The rally from 14,000 to 16,000 [points] in just a few days, and the subsequent collapse, suggests that traders had become too enthusiastic, and at the end it didn’t take much to send traders stampeding for the exits.”
The Japanese stock market has been gorging on easy money, pumped into the economy by the Bank of Japan in an effort to stimulate demand and investment. The fact that global stock markets have been rallying over the last few months, at the same time as commodities have been declining, indicates that the gains in Japan and beyond have been driven by central banks’ stimulus programs rather than fundamentals, Mr. Cieszynski says.
“I would not be buying Japan at this point. In fact, I’m looking for shorting opportunities,” says Brad Radin, portfolio manager at Radin Capital Partners Inc. The Toronto-based firm is in the process of selling its Japanese holdings, which represent between 2 and 3 per cent of the assets of its global opportunities fund.
Prime Minister Shinzo Abe’s plan to fight years of deflation with a stimulus plan that doubles the money supply is fraught with problems that make investing in the Japanese market a massive bet that Mr. Radin is not prepared to risk.
“Japan has huge demographic problems. It’s essentially a country of old people, and no kind of monetary policy is going to change that,” he says.
It’s widely thought that the success of “Abenomics” will depend on whether the prime minister can institute structural reforms to reduce government spending and make businesses more competitive. Mr. Radin says that based on his experience dealing with Japanese executives, he doesn’t hold out much hope for changes in the boardroom. “They are not [motivated] to make change. They are not up to their eyes in stock options like American CEOs. By and large, the people running Japanese companies are not interested in making big, bold moves to create shareholder value.”
The Japanese market right now is a good game for hedge fund managers, says Anthony Boeckh, a former editor-in-chief of the Bank Credit Analyst and now publisher of the Boeckh Investment Letter. “But it’s not a widows and orphans play.”
The Japanese government has tried unsuccessfully to fire up the economy with stimulus efforts before this latest attempt, launched late last year after the election of Prime Minister Abe. The thing that makes this attempt more credible is the government’s resolve, Mr. Boeckh says.
“I don’t think [the selloff] is the end [of the bull run] because this government is so committed to change and it is targeting the stock market,” he adds. “If the market continues to sell off, Abe will probably say he will double his stimulus efforts.”
The amount of stimulus that Japan’s central bank has already committed puts the country into what Mr. Boeckh terms “deep uncharted waters.” The challenge is that expanding the monetary base does not automatically translate into more bank lending and business investment. In fact, the easiest path for the money is straight into equities and real estate.
Similar to Mr. Radin and others, Mr. Boeckh says that major reform of Japan’s corporate sector is required so capital is not wasted and idle cash is returned to shareholders and put back into circulation. He wants to see the prime minister offer more details on how the government will make the corporate sector more productive and efficient. He also says success requires tax increases, reduced regulation, more liberalizing of the financial system, cuts to pension benefits and immigration reform.
These steps are the key signposts that investors need to look out for over the next six to 12 months to know whether the economy will be strong enough to support further growth in stock valuations. Without those reforms, Japan is liable to see its debt continue to surge to the point where the size of its interest-rate payments begins to cripple any chances of economic growth.