It tells you something about the state of some other industrialized countries when people are flocking to Japan to invest their money.
In particular, Japanese government bonds have been flying off the shelves lately, as sovereign-default-fearful bond investors flood out of Europe and into safer havens. The result has been a sharp drop in Japanese bond yields - the 10-year Japanese government bond is yielding as low as it did in the depths of the financial crisis in late 2008.
Julian Jessop, chief international economist at London-based research firm Capital Economics, notes that this is not only out of whack with other major markets - where yields are well above their credit-crisis depths - but also doesn't jibe with Japan's healthy economic rebound, which, at a pace of 5 per cent annualized, would seem to imply an upturn in bond rates rather than a downturn.
More importantly, the Japanese bond market is ignoring the darkening clouds surrounding Japan's own government debt problems. Bond yields have been declining even as the market has been screaming that the risks of Japanese defaults are growing.
DEFYING GRAVITY
In a research note this week, Mr. Jessop pointed out that as Japanese government bond yields have been falling, the risk of default - as measured by the cost of insurance for the bonds in the credit-default-swap market - has spiked to its highest levels since early 2009. This isn't normal; typically, rising CDS costs are accompanied by rising yields, as issuers must compensate investors for the increased risk they are taking on.
"This suggests that demand for a safe haven from problems elsewhere has trumped worries about Japan itself," he wrote. "However, we do not expect this to last."
A downturn could come as soon as the market absorbs the new Japanese government's mid- to long-range fiscal plan, which received lukewarm reviews after its release earlier this week. The plan doesn't envision a "primary" balanced budget (i.e. excluding interest payments) until 2021. That means Japan's debt-to-GDP ratio, already at more than 200 per cent, is likely to get worse over the next decade.
WILL THE NIKKEI FOLLOW?
Should the bond market cease its gravity-defying outperformance, it's fair to ask whether Japan's stock market could be far behind.
Tokyo's Nikkei stock index has slipped a tiny 2.2 per cent so far this year (as of June 24) in U.S. dollar terms, a better performance than the major U.S. stock indexes and vastly superior to the troubled European markets. The MSCI Euro index has lost 21 per cent in U.S.-dollar terms over the same period.
There's little evidence that the Japanese stock market has priced in the risks the country's heavy debt burden and growing sovereign risk pose to its growth outlook. Just as in the bond market, there's a dose of reality that Japanese equities are going to have to swallow at some point.
David Parkinson