Japan's Amazing Market Drama: New Update
By Doug Short
August 28, 2013
Note from dshort: It's been three weeks since my last close look at key Japanese data. The amazing rally in the Nikkei 225 hit its interim high on May 22nd, up 91.5% from its interim low in November of 2011. The steroid effect of massive monetary intervention subsequently evolved into an almost daily drama of high volatility.
What about Japanese government bonds? The closing yield of the 10-year bond on the day the Nikkei hit its 2011 interim low was 1.53%. It was cut in half to 0.75% a year later when the Nikkei hit its November 2012 low shortly before the steroid rally. The yield fell to its 2013 low of 0.44% on April 4th, the day that the Bank of Japan disclosed its radical redo of monetary policy. It rebounded to 0.94% on May 29th but has since dropped over 20 basis points.
A Look at the Historical Perspective
Here's a quick review of the Nikkei 225, the 10-year bond and inflation over the past few decades.
The table below documents the advances and declines and the elapsed time for the major cycles in the Nikkei.
The Nominal versus Real Nikkei 225
For most major indexes, we expect to see a significant difference between the nominal and real price over a multi-decade timeframe. But Japan's chronic bouts of deflation have kept the two metrics rather tight. Note that I've used a log vertical axis for the index price to better illustrate the relative price changes over time.
Japanese Bond Yields: How Low Can They Go?
Government bond yields in many safe-haven countries have plunged since the Financial Crisis, although the US 10-year, now hovering around 1.9 percent, is well off its historic closing low of 1.43 percent set in July of last year. The lesson from Japan is that the trend toward lower yields can last a very long time. Here is an overlay of the nominal Nikkei (linear scale) and the 10-year bond along with Japan's official discount rate. The 10-year yield hit its all-time low in June of 2013, about 10 years ago, at 0.43%. According to Bloomberg, it closed yesterday at 0.74%, although as I type this, the official data point from Japan's Ministry of Finance hasn't been posted, but Bloomberg puts the yield at 0.72%.
And here is a closer look at the 10-year yield over time with a log vertical axis to give a better sense of the relative change.
I mentioned that 10-year record low of 0.43%. When the latest round of BOJ easing was officially announced on April 4th, the yield closed that day at 0.44%.
The consensus view of the Nikkei's massive rally since last November, and certainly one that I share, is that it was essentially a result of the market's response to rumors and news of the BOJ's plan for the latest easing of last resort months before its implementation, with the falling Yen as the key driver.
Note that the Yen hit its interim low on May 22nd, the same day the Nikkei hit its recent peak. Now check out the inverse correlation between the currency and the equity index over the past 18 months.
What we've seen in Japan is an amazing chapter in the ongoing drama of economics and the market -- a drama that no doubt has a lot more in store for us.
For a better sense of the volatility since the impressive vertical trajectory to the May 22 peak, here is a daily chart with a Fibonacci retracement overlay. The with today's 204 point, 1.51% decline (not yet included in the Stockcharts daily series), the index is now even further below the lower Fib support.
The average absolute daily change in 2013 has been 1.47%, almost three times the S&P 500's 0.55%. Since the May 22 closing high, the Nikkei's absolute daily change has risen to 1.72%. So far in 2013 the index has had 13 days with a 3% or greater absolute change from the previous daily close, 11 of which followed the May 22 high. There have been five days with a greater than 4% absolute change, all following the May high.
Note: The "recessions" highlighted in the third chart above are based on the OECD Composite Leading Indicators Reference Turning Points and Component Series. I use the peak-to-trough version of data (peak month begins the gray, trough month is excluded), which is conveniently available in the FRED repository. As we can readily see, the OECD concept of turning points is much broader than the method used by the NBER to define recessions in the US.