• Prior to the financial crisis in 2007, when the U.S. equities were at their prior record-high level, the Nikkei was trading at over 18,000. Based on a level of 13,000, that means there would be a little less than 5,000 points, or 40% gains, just to regain the levels before the financial crisis.
• The yen’s level during that time was close to 120, implying even another 20% depreciation just to hit pre-crisis levels.
A further catalyst? Underinvestment in Japan
Despite Japan being the story of the year in 2013, I believe a catalyst for even further gains in Japan’s equities would be if investors removed their under-allocations to Japanese equities. There are two types of investors who appear to be under-allocated:
1) Institutions Late to Game: According to Goldman Sachs, global money managers appear to be underweight Japan versus their benchmarks.1 Japan’s remarkable performance run could cause many of these managers to underperform, and some are likely to respond by closing their underweight positions (buying Japanese stocks) so performance doesn’t diverge as much if Japan’s rally continues.
2) Japan’s Savers: Retail investors are becoming a growing presence in the market. For years, Japanese savers have seen equity values lose value from the peak of the Nikkei at approximately 39,000 to its current 13,000. According to a Wall Street Journal study of Japanese household balance-sheet data2:
a. A typical Japanese household has 55% of its assets in currency and bank deposits and less than 11% in equities and mutual funds.
b. The comparable data for the typical U.S. households: 15% in currencies and bank deposits and four times more equities and mutual funds—about 45% of their financial assets.
c. This study also showed that retail trading volumes have increased from about 20% of trading volumes in October 2012 to 31% of trading volumes this March. Greater participation from retail investors could cause even further gains.
d. To put this in perspective, Japanese households have $8.9 trillion in cash and bank deposits, while U.S. households only have $7.7 trillion.
e. Again, putting these cash figures in context, the market capitalization of Japan’s equity markets are less than $5 trillion, so Japanese households have enough cash to buy the entire Japan stock market and still have large cash balances in the bank. By contrast, the cash in the United States households would roughly cover purchases of only half the value of the U.S. equity markets.
Conclusion
The latest actions for the BOJ have the same goal: stimulate Japan’s economic growth. Deflation has been a major structural impediment, as Japan’s citizens curtail their consumption and keep large cash balances in savings accounts. Overtly, the fiscal and monetary policies announced are geared toward this end, but we believe that a positive side effect for Japan’s exporters is that many of these policies also encourage yen weakening. We believe that if Japan’s citizens begin to convert savings to consumption and investment in the equity markets, at the same time that Japan’s exporters are faced with the tailwind of yen weakness, the result could be very positive for equity investors.
WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ)
Jeremy Schwartz is director of research at WisdomTree Investments (NasdaqGM: WETF). This post was republished with permission from the WisdomTree blog.
Data source is Bloomberg unless otherwise noted.
1Dominic Lau, “Japan’s Nikkei Bounces 1.9%, Cyprus Still an Issue.” Reuters, March 18, 2013.
2Kana Inagaki, “Investors Take Plunge,” Wall Street Journal, April 6, 2013.