As late as 2010 the Japanese stock market was known as the perfect market for perma-bears. It was an ideal market for traders who were always negative on stocks and believed that every rally had to be sold. And indeed, the Nikkei 225 index did just that. It rallied and then came back, rallied and collapsed again. The Japanese economy was stuck in what reminded of the land of Narnia: always winter but never Christmas. Stocks would rally but soon they gave it all back and resume their downtrend. Now, however, this index is rallying to historic levels so let’s take a look at what kind of index is Nikkei 225 and what drives the index.
Nikkei is a reminder that a stock market that can have an extended bear market. Nikkei’s downtrend started in 1989 and was over only in 2013. The Japanese stock market winter lasted for 24 years. Therefore, buying and then selling the shares if the market doesn’t move higher can make a lot of sense. A lot more than the buy to hold strategy. In February 2021Nikkei rallied above 30,000 index points for the first time since 1990. Those buy-to-hold die-hards that bought the shares in 1990 had to wait 30 years before seeing their investments break even. And that’s without taking the inflation into consideration.
In August 1990 markets were shocked by the Iran invasion of Kuwait, which later on led to a seven-month-long occupation of the country and eventually to the Gulf War. This was a milestone in global history but didn’t obviously cause the downtrend in the Japanese stock market. Nikkei had already topped in December 1989 at 39260 index points and kept on sliding until it bottomed in 2012. The market started to rally only in 2013. While the collapse started with a banking crisis in 1989 the current rally has been fuelled by another kind of crisis. Coronavirus pandemic has prompted massive liquidity injections to the economies by the central banks and this has meant the stocks have moved in one direction only: Up.
How did the market ideal for perma-bears turn into a raging bull? To understand this we have to look at Japanese demographics. By this demography, we refer to the changing age structure of the human population in Japan. As a rule, the more young people you have in an economy the more labour force there is available for the employers to employ. This will, among other things, keep the labour costs low and attracts direct foreign investments to the country. At the same time, a growing number of young and working-age people means there is demand for the products and services. All this contributes to economic growth and supports the stock market. The problem in Japan has been the ageing population that doesn’t create economic growth. This has led to deflation and economic stagnation. This is why Nikkei 225 was such a perma-bear stock index. There just weren’t economic fundamentals to support the stock market in Japan. So, how can be a perma-bear turned into a market that rallies over 80% in a year? The answer is QE or ‘funny money’ from the government as Quantitative Easing has been also called.
The Bank of Japan has been over the years trying to create a wealth effect by first buying Japanese stocks through ETFs. Since spring 2020 this operation has been highly successful. At least, if measured in Nikkei 225 performance. This steepest phase in the rally started in April 2020 as it was clear that the central banks have to step up their QE game due to the coronavirus pandemic. The index has risen 80% in about 10 months. According to Bloomberg, the BOJ became the biggest owner of Japanese equities in July 2020. This shows how, just like in the late 1990s, (in the US tech stock bubble) fundamentals are not the reason for the high prices but a buying mania created by some deep-pocketed buyers. In the late 1990s, it was the investment funds doing the buying. Now it this buying frenzy fuelled by another group of investors with even deeper pockets, the central banks.
This bubble created by central bank QE money must, however, burst at some point. This point is likely to come when central banks start tapering their QE and investors realise that the only reason the valuations are this high is the cheap money created by the central banks. Each and every free market needs new inflows of funds in order to keep on rising. Once those central banks originated inflows start to dry up it’s time for the investors to run for the hills.
Chief Market Analyst
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