Interest in Japanese stocks sunk to its nadir at the end of last month. Then it turned.
The broad Topix of all 1,669 stocks in the first section of the Tokyo Stock Exchange is up 6.1% in the last four weeks. The strength of their surge in the last month has surprised me. But not the timing, or the direction.
International investors have been heavy sellers in Tokyo for quite some time. They tend to sell at exactly the wrong time, as I explained in my piece on August 30 - exactly four weeks ago. It seems many have made that mistake again.
"Maximum pessimism may be a sign that the tide is about to turn," I said in that piece. Which is exactly what has happened. I caged my terms that the tide "may" turn, so can't say I was 100% prescient!
The JPX-Nikkei 400 index has gained 8.7% since a low on August 26. That's even after a dip of 1.1% today, which has brought Japan stocks to the same levels as on September 12.
I recommend that investors buy index trackers following that index, if they're looking for broad Japan exposure. The JPX-Nikkei 400 picks out 400 particularly well-run Japanese companies, ones that are managed according to international standards of independent board representation, and so on.
For U.S.-listed exchange-traded funds, the iShares JPX-Nikkei 400 ETF (JPXN) (up 7.1% since Aug. 26) and the Xtrackers Japan JPX-Nikkei 400 Equity ETF (JPN) (up 7.2% since Aug. 26) tick that box. Since they are unhedged ETFs, they also reflect foreign-exchange movements as well as the underlying index.
I think of Japan as a steady but not stellar holding in an Asian portfolio. The Topix constituents tend to be well-established giants in conventional industries. Its largest sectors are transportation-equipment manufacturers, electrical-appliance makers and banks, pretty staid sectors, before you get to the Internet age and I/T stocks.
Sentiment on Japan does not reflect this steady dependability. Japanese stocks have been woefully under-represented in international portfolios, a legacy of the long, wasted years that followed the bursting of Japan's bubble in 1989. That changed with the election of pro-business, pro-reform Prime Minister Shinzo Abe, only for the enthusiasm in his plans for economic revival to fade.
Interest in Japanese equities hit an all-time low last month, according to the August edition of the World Economic Survey or WES, put out by the German research house Ifo Institute. That contrasts with the post-Abe glow, when Japan was the hottest market in the world in terms of sentiment.
The amount of stocks that overseas investors have now sold since the last surge in interest in 2017 more than cancels out any buying they did back in 2012. As of late last month, foreign investors are now net sellers to the tune of ¥3.5 trillion (US$33 billion).
Not everyone has missed the market's move. After heavy net selling in early August, there was a shift to net buying of Japan futures in September by international investors. The last two weeks have been particularly intense. Overseas investors bought ¥800 billion (US$7.4 billion) in futures on the Topix and the Nikkei 225 index this week, adding to the ¥1.2 trillion (US$11.1 billion) they purchased the week before.
Japanese stocks have rallied as the central Bank of Japan indicated that it may expand its stimulus program as early as next month. Combined with the second rate cut from the U.S. Federal Reserve, the punch bowl has very much been brought back to the party.
Japan has also agreed to a scaled-back trade deal with the United States. The most-exciting aspect of that is a deal on digital trade. Japan also agreed to reduce tariffs on certain U.S. farm goods like beef and pork, while Japanese manufacturers get a break on turbines, machine tools, green tea and flowers. Flower futures must be blooming! It's a limited deal.
The BOJ already has short-term interest rates in negative territory, at (0.1)%, and a pledge to keep yields on 10-year mid-term government bonds around 0%. In other words, you're penalized for keeping your money in cash. The Japanese government desperately wants households to spend, and companies to invest.
BOJ Governor Haruhiko Kuroda could take rates further into negative territory, although that starts to get a little ridiculous, and questionable in effect. The BOJ stood pat on rates on September 19, the day after the Fed cut.
But Kuroda said then that the central bank is "more eager to act given heightening global risks." He said the BOJ board will scrutinize economic and price developments "thoroughly" at the quarterly review of its strategy on October 30-31, "to decide whether to ease."
More likely action would be for the BOJ to step up an existing program where it buys ETFs and real-estate investment trusts. That's clear, direct support for the equity market.
Investors appear to have shaken off any concerns about an increase in Japan's consumption tax that goes into effect on October 1. The sales tax will rise from 8% to 10%, which is sure to dent short-term consumer spending. How much remains to be seen.
Sales of TVs, washing machines and vacuum cleaners have been brisk before the tax hike, according to the Japan Times. But the pre-tax buying has been patchy, with car sales unmoved because the government also plans to cut the auto tax by up to ¥4,500 (US$42).
The government hiked the sales tax from 5% to 8% in 2014. That precipitated heavy consumer spending prior to the increase, and a crash in purchases after the tax went into effect. The fluctuations in consumer spending should be less whip-saw this time around, with a smaller increase.
The idea behind raising the consumption tax is to tackle Japan's public debt. Over ¥1 quadrillion, it is the largest of any developed nation. Abe also wants to offer free preschool education, to encourage mothers to return to the work force.
Raising the sales tax now, with wages flat, and geopolitical risks high is the "worst possible timing," according to Etsuro Honda, a former economic adviser to Abe who helped design the Abenomics program.
Besides that huge debt, Japan also holds ¥650 trillion in assets, while the central bank has bought ¥460 trillion in long-term government bonds. Those assets almost cancel out the national debt, he notes.
We will see if the international interest continues beyond the sales-tax increase, into October. International investors dominate the active trading in Japanese equities. So it's their participation that will drive the Topix and JPX-Nikkei 400 next month.
Foreign investors have been particularly heavy sellers of active Japan-focused funds. Instead, there has been a major shift into passive index trackers. Where active funds accounted for 65% of Japan-focused assets at the peak of Abenomics fever in 2015, the balance is now roughly 50% active, 50% passive. Those ETFs above remain the clear play if the buying continues, and the BOJ decides to act.