Weekend articles: Downward pressure on the Nikkei in 2008

January 6, 2008
By Ken Worsley

Market watchers are already aware that Friday was Japan’s first trading day of 2008, and that the Nikkei closed down 616.37 points, finishing at 14,691.41. This was the largest fall ever for an opening day of trading and sent the Nikkei index to its lowest level since July 2006.

While there are certainly going to be arguments put forth (including here) that Japanese equities are currently undervalued and that some industries have solid investment promise, it’s time to look just a bit at the downside risks for Japan’s stock markets in 2008. I should stress the phase “just a bit” since we’re primarily going to be look at a set of articles that were published over the past few days.

First, we know that crude oil futures traded over $100 a barrel during Friday’s session in New York, which was bound to put downward pressure on the Nikkei. What didn’t get so much mention was that gold and grain futures were also pushed to record heights. In an article published Saturday morning, the Nikkei simply stated, “Investment funds and others fleeing the financial markets are believed to be driving gains in the commodities markets.”

“Believed to be” and “actually are” are two different things, though we have to agree with that assessment, especially when we look at the funds flowing into commodities following the breaking of the subprime crisis in the US. Perhaps a commodity bubble will be one consequence of that meltdown.

At any rate, higher commodity prices should be driving up costs for companies, which should in turn drive up prices, which might put a dent in consumer spending. We’re already seeing how increased gasoline prices in the US are having some effect on consumer spending. This will hurt bottom lines at retailers and others sensitive to domestic demand. With about 55% of Japan’s GDP derived from consumer spending, medium-term high commodity prices could cause some pain at the nation’s more inward-looking firms (which is most of them), and thus drive down stock prices in sensitive industries.

Decreases in consumer spending may be on the way, or already happening in some sectors - especially with regard to luxury goods. As the Nikkei put it in an article published on Friday:

During the economic bubble, Japanese consumers flocked to high-end luxury stores in Europe and the U.S., gorging on big-ticket items. But now, these same consumers are relegated to buying from the same designers’ lower-priced lines.

Why?

Japan’s decaying international competitiveness and weak yen have made it relatively poorer than other nations.

We should point out that while this is happening, Reuters published an article entitled “Japan’s new rich party like it’s 1989,” which points out that “the number of people in Japan holding more than $1 million in financial assets grew 5.1 percent in 2006 to some 1.5 million, about three times as many as in China, Taiwan and Hong Kong put together.”

Hopefully that 1.19% of the country will be able to continue spending like it’s 1989.

Even if that happens, however, there are still structural problems that make investors wary about putting their money into Japanese equities. In an article published by the Japan Times on Friday, Tokyo Stock Exchange President Atsushi Saito was quoted telling those present at the 2008 opening of the TSE, “…[O]ur country is losing its appeal as an investment target although huge excess funds, including oil money, are flowing across global markets.”

Financial Services Minister Yoshimi Watanabe told the crowd that it would be important to shift funds from the public to the private sector, and from personal savings to investments. He also said, “Prime Minister Fukuda has been enthusiastic about promoting a financial revolution. And we acknowledge this serious situation and intend to promote a big financial revolution.”

We’re going to have to take a wait-and-see approach on that, though some small steps have been suggested.

At any rate, the final article that caught our eye was an interview with TSE President Saito that was published in the Nikkei on Friday morning. In the interview, Saito goes deeper into his thoughts on the course of Japan’s equity markets:

Q: Foreign investors seem to be fleeing Tokyo’s capital market.

A: Yes. Among developed countries, only the stock markets in Japan and Italy saw prices fall in 2007. Japan at the moment is not a place where overseas investors are willing to invest.

Government regulations and court rulings regarding hostile takeover bids prompted many foreign companies to leave the country last year. The Japanese government and the financial industry want to turn Tokyo into an international financial center, but it has all been talk so far, with few concrete actions taken.

Investing in a company is a way of showing that one rates a firm highly. Japanese corporations with high proportions of foreign ownership are all top-notch entities. Japanese companies appear too wary about being taken over. Managers must draw a clear line between a takeover and a warning from shareholders.

Domestic businesses (in every country) invest in overseas companies and vice versa. That is the formula that makes it possible to sustain the prosperity of an economy.

…

Of the 63 million workers in Japan, only 2.7 million are in the financial sector, compared with 15 million in manufacturing. In the U.K., as many as 7 million people work in the financial industry.

…

Q: It seems that the momentum for reform has faded compared with 2003, when the financial crisis hit Japan.

A: The financial sector has never really tackled “reform.” Financial institutions have merely returned from the brink of death where they had been pushed in 2003. True reform would have been more fundamental and sweeping. Their pain may have abated, but that doesn’t mean they have regained their strength.

We won’t comment on the possible role of demographics and any connection between Japan and Italy. What is significant is Saito saying that regulations and court rulings are causing foreign investors to think twice about taking stakes in Japanese firms. Of course, this is fallout from the Bull-Dog/Steel Partners incident of 2007 that was predicted here (and must have been elsewhere).

The other quick bit that caught my attention was Saito saying, “The Japanese government and the financial industry want to turn Tokyo into an international financial center, but it has all been talk so far, with few concrete actions taken.”

Is the translator having fun here? I’m willing to bet Saito said 具体的, and that was translated as ‘concrete’ - which gives the English translation a double meaning. Certainly, no concrete has yet been poured in an attempt to build this new ‘financial district’ that was first suggested by the Abe administration. Back in June, we reported that the Ministry of Finance was getting ready to sell 2.4 hectares of land near Otemachi Station for about 370 billion yen, and surmised that it would be part of Tokyo’s new ‘financial center.’ No word yet on who that land went to.

At any rate, Saito’s comments show yet another reason why downward pressure might be on the Nikkei this year - investors just aren’t sure if the government is serious about carrying out the right kind of reforms. Window dressing just won’t hack it. Shiny new buildings are nowhere near enough. Investors are going to want to see much more, and unless they start to believe that the government can deliver over the medium/long term, it will be difficult to see much bullishness on the Nikkei in the first half of 2008.

Filed Under Business, Economics, Equity Markets, Nikkei

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15 Responses to “Weekend articles: Downward pressure on the Nikkei in 2008”

WG on January 7th, 2008 4:52 am

Perhaps a commodity bubble will be one consequence of that meltdown.

I think a commodity bubble was already on the way. Certainly it has been with gold, though subprime has only helped to accelerate, and perhaps shorten it. They do move in cycles.

At some point the commodity prices won’t make sense, aside from oil. They will unwind hard.
Contrarian on January 7th, 2008 10:42 am

“Financial Services Minister Yoshimi Watanabe told the crowd that it would be important to shift funds from the public to the private sector, and from personal savings to investments.”

How would shifting funds from savings to investments do anything except appreciate the prices of assets that the wealthy currently own in mass? In fact, unless these savings went into bonds (instead of the equities implied), the shift would technically limit the ability to finance CapEx. This sounds like a ploy by the ruling class and its control over the media to play the “Japaneseness” card and con ordinary Japanese people into propping up the stock market.

WG: That’s an axiom, but at what point won’t commodity prices be justified? Official monetary policy right now is that deflation is so devastating that any amount of inflation is preferable. The easing that has already taken place is similar to that which caused the commodities mega-cycle that has been taking place for nearly 10 years now. I’m not an oracle, but isn’t it possible that what central banks and monetary authorities hope to accomplish in easy could actually do the opposite and squeeze margins?

A friend of mine brings up the idea of the ineffectiveness of the massive easing that has taken place in Japan and points out that the easing might not cause inflation or even stop deflation. I think that the big difference here is that this is globally systemic, not just country-specific. The easing in Japan was isolated, thus the easing had an unintended consequence–instead of fueling the domestic economy, the capital was exported to super-fuel the rest of the world, where there were higher expected returns. The 35 trillion yen that the MOF created between Jan. 2003 and March 2004 was exported capital.

This time around, the global economy is slowing, “Western” monetary authorities are easing and emerging economy monetary authorities/monetary authorities who wish to control their currencies’ appreciation against the dollar are mimicking (and tolerating higher inflation) for the time being. With everyone easing, there’s no place to export the capital and, thus, I don’t think this simultaneous real-estate/equities unwinding will affect the prices of commodities and durables as much as the new money flowing into the system.

Yeah, that’s a lot of what-ifs, maybes, and I-wonders. I realize that it’s as unlikely and ostensibly illogical as any other idea about where markets are heading. It’s a blind-folded dart throw.

I like what Jim Rogers wrote about commodities. He said something like, “When you see a farmer on the cover of The Economist, you hear your neighbor talk about how she just made a killing in soybeans, and you see solar panels and windmills everywhere, you’ll know that the commodity bull is over.”

I’ll throw you one of the criteria right now. I made a killing in grains last year. ;)
Smitty on January 7th, 2008 11:58 am

Nikkei was getting pounded this morning, came back a bit but is still down on the day. Might be about time to go discount shopping.
J on January 7th, 2008 3:10 pm

I’m buying a Nikkei fund when it dips below 14,000… then selling when it gets to 16,000. You can do it on Etrade in Japan for a few hundred yen.

WG-Exactly, the U.S goes from bubble to bubble, comod’s are already high and maybe the next bubble.
Ken Worsley on January 7th, 2008 4:18 pm

J, Actually you made me think that we need info on opening online accounts for people who live in Japan. I think it was Japan Inc that did a good one a while back - actually, it’s here: http://www.japaninc.com/mgz_summer_2006_day_trading

Should link to that somewhere on here…
J on January 8th, 2008 5:09 pm

so when are you going to let me write some investing articles here…

Making 40K a year and being worth 850K+ has gotta mean something, right?
Ken Worsley on January 8th, 2008 5:17 pm

I’ll see what my lawyer says…
B Dog on January 8th, 2008 7:53 pm

The 35 trillion yen that the MOF created between Jan. 2003 and March 2004 was exported capital.

How much of it? At that time they were intervening in FX markets, but the goal couldn’t have been to have the money shipped abroad.
Contrarian on January 9th, 2008 8:12 am

The goal was absolutely to ship the money abroad. The BOJ/MOF were trying to depress the value of the yen by:

1. Creating 35 trillion yen
2. Selling those yen in the open market to buy mostly dollar denominated assets

To answer your question of how much, the answer is 100 percent.

But, to answer the question vis-a-vis the effects of the ZIRP and the effect it had on capital exports, I don’t know how to quantify it (and the “mileage may vary” in studies that try to quantify the yen carry trade, as far as I have seen).

The point that I was trying to make in my original post was that the easing in Japan was ineffective because the money left the system. The current mass easing that is beginning with the “western” economies might not be able to escape like the Japan case, given that capital markets have been globalized into one big soup. The endogenous money from the easing could actually do what they expect it to this time because of lack of places to export it. Imagine a large-scale version of China (where the excess liquidity is sloshing around and inflation is much higher), except that the capital controls are not from a communist central planning authority, but from market forces.

I agree that commodities will be the next bubble. Given that commodities have had such extraordinary gains over the past nine years, the question WG raised was when will the prices no longer make sense (does this asset class have legs?)? I presented the above case.

I don’t want to sound like a charlaton. I don’t know what will happen. I’m just saying that I’m not ready to sell my commodities and I’m going to continue to build my positions this year because I think they look better than equities or money market.
B Dog on January 9th, 2008 4:32 pm

Certainly they were looking to depress the value of the yen, which is in the interests of many. But I wonder about the claim that 100% of it was intended to be shipped abroad. That’s going to have to be backed up with some evidence.

For easing to have worked, they needed money to stay in the system. I don’t know how much. Some would naturally go overseas. But I’m not sure about claiming that 100% of it was intended to go abroad from the get-go.
Contrarian on January 10th, 2008 11:35 am

“That’s going to have to be backed up with some evidence.”

OK, fine. In January 2003, Japan’s foreign currency reserves were reportedly ~459 billion dollars. In March 2004, Japan’s foreign currency reserves had increased to a massive ~797 billion dollars. This accounts for the 35 trillion yen that I mentioned above and you are questioning.

You are kind of helping out my case. You mention that for the easing to have worked, the money needed to stay in the system. But not enough did and that’s why the last 15 years happened the way they did in Japan.
Ken Worsley on January 10th, 2008 10:22 pm

J,

I’m buying a Nikkei fund when it dips below 14,000…

Looks like you’re going to get your chance sooner rather than later…though we may see some discount buying tomorrow (wait and see what the NYSE does):

Anyway, Nikkei was down 211.05 to 14,388.11 today.
WG on January 11th, 2008 10:57 pm

Sooner might be right…down 277.32 today! 14,110.70! Who else out there is cheering it down?
J on January 12th, 2008 4:59 pm

I might be waiting til’ 13,500 at this point although that would be oversold.
Bilder on January 16th, 2008 1:51 am

Nikkei went below 14,000 today. WG, I’m with you. It’s not going to get pretty soon, with more big bank earnings statements due this week. US banks selling off their own limbs just to stay trading.

But when it does get good, it will get very good.

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Weekend articles: Downward pressure on the Nikkei in 2008

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