It has been hardly four months since Japan elected Shinzo Abe as prime minister, yet market participants have clearly placed their bets behind Mr. Abe’s plans to resuscitate Japan’s economy from the grip of deflation and slow growth (referred to as “Abenomics”), as the Nikkei 225 Index rallied from below 9,000 in early November 2012 to over 13,000 in early April 2013.
Central to Abenomics was appointing a new head of the Bank of Japan (BOJ), Haruhiko Kuroda, who is charged with enacting bold monetary policy. To be fair, Japan experimented with quantitative easing, or the expansion of the bank’s balance sheet into non-traditional assets, in the 1990s, prior to its being more fashionable among today’s global central bankers. Yet the BOJ’s previous actions failed to end deflation, get Japan’s economy into gear, or convince the market its policy makers had the conviction to continue trying “whatever it takes” to end deflation. [Currency Hedged Japan ETF Rallies on Plunging Yen]
In a way, the market can do a lot of the heavy lifting for the Bank of Japan by sending the yen’s value lower and easing pressure on Japan’s exporters. But the market must believe the BOJ will not back down.
Beating high expectations
Expectations for Mr. Kuroda were quite high for his first meeting, held on April 3 and 4. The yen had already weakened from below 80 on November 13, 2012, to 93.44, as of the close of April 2, 2013—a 15% depreciation against the U.S. dollar.
If bold, decisive action contributes to inspiring credibility, then Kuroda and the BOJ’s announcement on April 4 certainly did their part. Policies included plans to:
• Double the Monetary Base: Increasing the levels of cash and bank deposits from ¥138 trillion to ¥270 trillion by the end of 2014. Putting these numbers in context, this amounted to an additional ¥7 trillion a month of additional purchases, which is nearly equal to the amount of purchases the U.S. Federal Reserve is doing in its monetary policy of $85 billion a month (despite Japan being one-third the size of the U.S.). Given the relative sizes of their economies, one might say Japan’s purchases are three times more impactful than those of the U.S. Federal Reserve.
• Purchase Longer-Maturity Government Bonds: Extending the weighted average duration of Japanese government bonds from less than three years to approximately seven years, and even allowing the purchase of the 40-year bond to do so. Some interpret this as the Bank of Japan funding the government by printing yen.
• Double Equity Purchases: Increase the purchases of exchange-traded funds from ¥1 trillion a year to ¥2 trillion.
• Double Real Estate Investment Trust Purchases: Increase the purchase of real estate investment trusts from ¥30 billion a year to ¥60 billion.
Nikkei reaches 13,000, Yen 100 per USD—where does it go from here?
During 2012, the yen reached its strongest point on February 1—76.20. With current levels near 100, the yen has weakened significantly. Over the same period, the Nikkei 225 Index rallied nearly 50%. Is there still room for more? To provide context, I believe that it is important to consider:
• The Dow Jones Industrial Average and S&P 500 both surpassed their all-time highs (set prior to the financial in October 2007) during the first quarter of 2013.
• Japan’s all-time highs were set in 1989 during one of the largest bubbles in history, where Japan’s overall market was trading at valuations similar to technology stocks within the S&P 500 Index during the technology bubble in 2000 in the U.S.