Japan’s Financial Markets Face Troubled Times : Securities: Concerns about higher interest rates and geopolitical unrest have sent stocks tumbling, depressed bond prices and weakened the yen.
The magic could be over for the roaring Tokyo stock market, with a depreciating yen and higher interest rates combining to pull the plug on a bull run that has lasted five years, analysts say.
Although the experts still predict a strong economic growth in the 4-5% range this year, the recent performance of the Nikkei average reflects an increasingly gloomy view of how Japan’s once booming financial markets will fare in the months ahead.
The index ended last week at 36,836.54 points, down 4.8% from the first day of trading this year. Prices moved with erratic volatility since the Nikkei shed more than 650 points on Jan. 12 and plummetted another 666 points last Tuesday, when trading resumed after a national holiday.
Market commentators coined a term for the new money environment, the “toripuru yasu,” or triple cheaps: cheaper yen, cheaper bonds, and cheaper equities.
Gone are the “triple merits” that fueled the inexorable rise of Japanese stock prices since the mid-1980s: strong yen, low interest rates and declining oil prices. Gone, too, are wildly optimistic forecasts of the Nikkei, an index of 225 shares, soaring to the 45,000-point level by the end of the year.
“I don’t think it’s totally gloom and doom, but this is not a happy time for investors in Japanese stocks,” said James E. Russell, an analyst with Merrill Lynch Japan.
Much of the blame for the new year’s bearishness in Kabuto-cho, as Tokyo’s stock market district is known, is placed on softening prices in the government bond market. Anticipation of higher interest rates, along with jitters about the geopolitical situation, have been driving bond prices lower.
Tokyo traders are exhibiting an inordinate concern with the troubles of Soviet leader Mikhail S. Gorbachev. Last Wednesday, bonds were reportedly sold on rumors that Gorbachev had resigned because of domestic civil strife.
Vague pronouncements by the new governor of the Bank of Japan, Yasushi Mieno, were also seized upon by the bond bears, who fear another hike in the official discount rate will increase the yield gap between the money markets and bonds, therefore further depressing bond prices.
Mieno has hinted at raising the discount rate--the amount that the Central Bank charges to loan cash to financial institutions--once again as part of a tighter money policy aimed at controlling inflation and boosting the sagging yen.
Tokyo consumer prices rose at an annual rate of 3% in December--too high for the tastes of Bank of Japan officials. Also, higher interest rates at home would be expected to draw more support for the yen, which has crept up above the 145-yen-per-dollar mark since the beginning of the year.
Mieno’s predecessor “went out of his way to avoid shocking the market,” Merrill Lynch’s Russell said. “But interest rates have had a much more active effect on bonds and stocks since Mieno took office” last year.
The Central Bank last raised the discount rate on Christmas day, by a half-point to 4.25%, and there is much speculation of another half-point hike by March. Yield on the benchmark 10-year government bond rose to 6.87% last Thursday, the highest level since February, 1985.
Three-month certificates of deposit are currently offering 7.05%, and the widening yield gap between earnings-per-share in stocks and interest paid on money market funds is another signal of alarm for investors. The figure is approaching the 5% mark that preceded the October, 1987, crash in global markets, analysts say.
“Everything comes down to the yield gap,” said Simon Smithson, a Japanese equities analyst at Kleinwort Benson International in Tokyo. “If the bond market stays at this level, then stocks are going to come down more. The bond market can’t rally unless the yen rallies, and the yen isn’t going to rally in the current set of economic and geopolitical circumstances.”
Paradoxically, the three hikes in the official discount rate last year had negligible effects on the booming stock market, which prompted one veteran stock market analyst to suggest that the recent correlation between share prices and fundamental factors, such as interest rates, is being exaggerated.
“There is no economic reason for the bond market behaving the way it is now,” said the analyst, who spoke on the condition of anonymity.
Indeed, herd psychology and the sheer weight of excess liquidity have played such an extraordinary role in the bull years of the Tokyo Stock Exchange that many skeptics have warned that the soaring Nikkei average reflected a bubble that is bound to burst one day.
Indeed, foreign investors once again became net sellers of Japanese stocks late last year. Average price-earnings (P-E) ratios of about 60 are common on the first section of the Tokyo exchange, which is about four to five times the level on the New York Stock Exchange. (The P-E ratio is the price of a share divided by the annual earnings per share, a standard measure of a stock’s fundamental value.)
But the Tokyo market is widely believed to be closely managed by Finance Ministry authorities, and despite the extreme volatility of recent weeks, there are skeptics who see the recent decline of share prices as a controlled correction unrelated to bonds, interest rates and foreign exchange.
Once domestic political uncertainty is cleared up after the Feb. 18 general election, in which the ruling conservatives are expected to win enough seats to retain their 35-year hold on the government, the stock market will resume its climb, this theory goes.
But believers in economic fundamentals see a more pessimistic scenario, that long-term interest rates will go has high as 7% and that the Nikkei index will sink to the 36,500 level, or below, in a prolonged slump.
“We think it will continue on the downside, but it’s always possible that there could be a technical rally in the bond market and that equities will stabilize,” said Kleinwort Benson’s Smithson. “After the election and the next discount rate rise, you may begin to get an indication that the worst is over.”
