Tokyo: the latest stock market darling

Japan’s leading stock market index, the Nikkei 225, on Tuesday reached its highest level in 26 years at 23,951, securing a 24- percent rise in value since a sudden growth spurt began in September.

Topix, the broader Tokyo index which tracks the roughly 2,000 largest companies on the exchange, also surged nearly 20 percent since the beginning of the fall.

This stellar performance — which also saw the Nikkei climb 5 percent since the start of the year — has encouraged many analysty and institutional investors to place Japan at the top of their buy lists for 2018.

The surprise rally began in September when Prime Minister Shinzo Abe called early parliamentary elections, which led foreign investors to pump significant amounts of capital into the Tokyo stock market, having held back sharply in the first half of the year. 

They argued that an election victory for Abe’s conservative Liberal Democrats would ensure the continuation of Abenomics, the ultra-loose monetary and budgetary policy named after the PM, and implemented to reverse more than two decades of economic stagnation.

The main purpose of Abenomics was to stave off deflation and included a weakening of the yen. As a side effect, stock prices have been driven up.

Revival after 30 years

The sudden revival of the Nikkei and Topix should not be taken for granted though. No stock market has ever reached as high as Japan as a result of a speculative bubble. Cast your mind back to the end of the 1980s, when the Nikkei was trading at just under 39,000. That’s still nearly two-thirds higher than Tuesday’s latest milestone, before it plummeted by half when Japan’s central bank raised interest rates several times.

Around the same time, the Imperial Palace in the center of Tokyo was said to be worth more than the value of all real estate in the entire US state of California. Again, that incredible bubble quickly deflated, and the economic malaise that followed in the 1990s was described as Japan’s lost decade.

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Some 26 years later, the Japanese stock market is riding high again. But the scale of this resurgence can really only be understood if one sees the historical context. In January 1992, the novel “Rising Sun” had just been released, in which author Michael Crichton warned of a Japanese conspiracy against the US. At the time, the plotline was so plausible that the book quickly became a best seller and was then turned into a film starring Sean Connery, Wesley Snipes and Harvey Keitel. But today, following two decades of rising debt and falling stock prices in Japan, it is hard to understand why Western audiences and leaders were so worried.

Japanese women at Tokyo Stock Exchange (Reuters/K. Kyung-Hoon)

While most investors expect another bumper year for the Tokyo stock market, some pundits caution that global and local risks remain high

Lengthy recovery

Twenty years after the Asian financial crisis that saw the collapse of Yamaichi Securities and Hokkaido Takushoku Bank, Japan’s economy has achieved a revival thanks mostly to Abe, who was elected in 2013. Boosted by a robust global economy, Japan is once again running at full speed and has grown for seven consecutive quarters, achieving its second longest boom of the postwar period.

Japan’s central bank, the Bank of Japan, has also provided economic stimulus with its massive asset purchase scheme. In less than five years, it acquired more than 40 percent of all government bonds, weakening the yen, and thereby boosting the profits of Japanese exporters, while at the same time, averting the threat of a debt crisis.

Slowdown in 2018

However, many analysts warn that economic growth will slow in the coming year. Following 1.5-percent growth in the current fiscal year to March 31, Japan’s leading investment bank Nomura expects growth to fall back to 1 percent. The economic boost was too weak to be felt by most of the public, Nomura’s analysts wrote in a recent report. Without higher productivity there could be no wage growth, they said. In addition, Japan’s strong export growth is based on investments in replacement goods and not due to an increase in production capacity.

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“It is unlikely the new year will repeat the success of the current one,” said Japan analyst Stefan Grosse of Norddeutsche Landesbank (NordLB) in December.

Japan is yet to see a major boost in domestic consumption, which accounts for 60 percent of economic output. After 1.7 percent growth over the past year, Grosse expects consumption to ease to 0.7 percent this year. Although the Japanese government is planning tax breaks for companies that pay higher wages, implementing this idea is likely to be complicated.

Risks on horizon

But still, analysts are mostly optimistic about the Japanese stock market, largely because of the Bank of Japan’s extremely loose monetary policy. The investment fund Wisdom Tree cites low stock valuations, positive earnings and the weak yen for its bullish prediction of further market highs, particularly among Japanese exporters.

German asset manager Lingohr & Partner describes what it says is a market “full of value opportunities,” pointing to many firms’ high cash reserves and profitability.

The US investment bank Lazard agrees that Japanese investments are “back on the agenda,” while US fund manager Janus Henderson predicts some undervalued small companies are potential acquisition targets.

The Swiss bank UBS meanwhile takes a more cautious stance, warning that the yen is already heavily undervalued. Another risk would be a stronger-than-expected reduction in the purchases of securities by the Japanese central bank, which it says could mean an exodus of the big foreign investors just as quickly as they returned.