By Richard Lie
Not so long ago, post-war Japan was talked about in the same reverent tones as China is today. Its economy was the envy of the world; its work ethic and productivity levels were off the scale, and its manufacturing prowess turned it into a behemoth- the second largest economy in the world. Then in the Eighties, something unexpected happened, something that hadn’t happened since the Great Depression. Prices started falling right across the board, and they continued to fall. A long-term deflationary spiral kicked in, and Japan’s growth miracle transformed into a case study in ‘what-notto-do’ for governments and central banks
around the world. It was a vicious cycle. To tackle falling prices, declining sales and plunging profits, the Japanese corporations were forced to make lay-offs and pay cuts. The ‘job-forlife’ tradition was disbanded, incomes were dropped and consumers cut back on their spending. Deflation also created a higher real interest rate, which in turn reduced the appetite for capital expenditure and investment. When a country gets trapped in a deflationary cycle, it’s very difficult to get out. Like diabetes, it induces other complications and makes the patient worse.
Enter Doctor Abe (aka Prime Minister Shinzo Abe) and his radical expansion plans, including massive levels of QE. After almost two years of intensive care, an economy, which was once on life support is now finally starting to show signs of real life. In late June, Abe declared triumphantly that deflation had ended: “Through bold monetary policy, flexible fiscal policy and the growth strategy we have reached a stage where there is no deflation,” he announced. It was a bold call, because growth remains low in Japan, and inflation hasn’t really taken hold either. However, it might mark an important turning point. QE will continue to provide a tailwind, and the charts show that Japanese equities are starting to look attractive for the first time in decades. One step at a time… The sun will rise again – one step at a time…
‘Four Steps’ to recovery
1. The big picture
Japan’s stock market has been going nowhere for a long, long time. To put things in perspective, when I was head of technical analysis at Dow Jones in London in 1990, the market value of the Japanese stock market was about 50 per cent of the value of all world markets combined. An extraordinary figure even back then. (Today the Japanese stock market is worth less than 10 per cent of the world market, while the US is worth a third.)
2. Drilling down
Recent price action has been more positive. Japan’s Nikkei 225 started to climb when Shinzo Abe led the LDP to a landslide victory. Following his command, the Bank of Japan unleashed a torrent of liquidity: almost three times the current pace of the Federal Reserve printing presses. The results have been spectacular: the Nikkei is up 70 per cent since November. (The Yen has also sold off heavily.) I expect the 30-year low to hold, but remember that Japan is still home to immense volatility. I am targeting a 25 percent rise over the next 12 months, and higher in the years ahead.
3. Recent action
The “Abe effect” ran out of steam last year, at 16,000, and has been forming a potential ‘rounding top’ i.e. a bearish pattern. It could mean lower prices in the weeks and possibly months ahead. I expect the current trading range to continue playing out over the next few months, but any break of 12,500 would bring the 30-year-low back into play. (Remember this is a highly volatile market.) Having said that, I would view future weakness as an opportunity to buy a longterm position in what could be an important secular bottom in the months and years ahead.
4. The relative story
Chart A & Chart B
Sometimes it can be useful to look at relative performance – ie. how the Nikkei is faring against other benchmarks. Chart A shows that Japan has been outperforming the rest of Asia over the last two years. This is positive information, which indicates that portfolios are being reweighted in response to Prime Minister Abe’s expansion plans.
Chart B shows that Japan is also outperforming the Dow Jones Industrial
Average (the US ‘supercaps’). This ratio shows a possible change in trend as well,which could provide a strong tailwind for Japanese stocks owners in the years ahead.
There’s a lot happening in Japan right now. It’s an interesting market for economists and market watchers. Abe’s aggressive experiment with QE will fill the economic and trading textbooks for years to come. At this stage, we don’t know how it will play out, but the charts seem to be pointing to a secular market bottom in Japanese equities. Could we go marginally lower? Yes, but the next couple of years should provide an opportunity to buy this market at a level that won’t be seen for generations to come.
Richard Lie is ASIC licensed, the founder
of the hedge fund Crusader Capital
Management, and the stock advisory service
www.stockradar.com.au, which is currently
offering FREE TRIALS.