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Nikkei more volatile and less representative than ever

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The Nikkei 225 Average is now one bad day away from bear market territory at its recent rate of decline. The Topix, meanwhile, is a couple of such days away from that level. That difference is meaningful.

The Nikkei, like the Dow Jones Industrial Average, is an anachronism. Sure, 225 stocks are a better representation of a market than the Dow's 30, but the basic point still applies: weighting indices by price, not capitalisation, leaves high-priced stocks to be swayed by market mood as much as fundamentals – and indices at the mercy of narrow investor fads. Take Fast Retailing and Toyota. The first, owner of Uniqlo, accounts for 9.2 per cent of the Nikkei with a market capitalisation of 3.5-trillion yen ($365-billion), but 0.4 per cent of the Topix. Toyota, with six times the capitalisation of Fast Retailing, is less than 2 per cent of the Nikkei and only 5 per cent of the Topix.

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It is unhealthy to have one-tenth of the best-known benchmark in such a giant market accounted for by a single retailer. Especially one where investor enthusiasm this year lifted the stock 90 per cent at its peak, nearly doubling its forward price/earnings ratio to 42 – about twice the industry, and its own, average. Put in terms of likely profit contributions and retailers' small role is very stark: Carmakers will account for 28 per cent of a one third-plus total rise in recurring profits expected this financial year, according to Nomura, while retailers will produce 2 per cent of it. It really is easier to reflate asset prices than consumer confidence.

Nikkei followers have now seen exactly half their previous 50 per cent year-to-date gains disappear in two weeks. Trackers of the far broader Topix are off 45 per cent from their peak and up 27 per cent for the year. Small comfort is better than none. Still, what next? After all, Japan's prospects have not changed, just market mood. Alas, that is being driven by the Nikkei, where implied volatility has doubled this year, while the Topix's has risen just 50 per cent. A market mood led by a more volatile, less representative index is hardly likely to settle nerves.

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