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TOKYO – In June 2015, Governor Haruhiko Kuroda turned heads everywhere by suggesting investors start thinking of the Bank of Japan as the Bank of Peter Pan.
“I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it’,” he said of the BOJ’s effort to lift the economy and asset prices. “Yes, what we need is a positive attitude and conviction.”
Five-plus years on, it’s clear punters took Kuroda’s rhetorical leap a bit too literally for comfort as the Nikkei 225 Stock Average achieves altitudes not seen in 30 years – and during an attitude-wrecking pandemic, too.
Monetary authorities have been venturing into uncharted territory for a number of years now. In the BOJs case, that meant buying so many stocks over the last five years that it has effectively nationalized the Tokyo exchange.
But the last 12 to 14 months of Covid-19 grounding economies around the globe saw the BOJ and peers venture into the central banking version of Neverland, and then some.
In fact, the BOJ’s cartoonishly huge purchases have it becoming yet the latest “meme stock.” Just like GameStop, Blockbuster and Nokia in recent weeks, the BOJ’s shares on Monday surged nearly 20%, the biggest rally since 2005.
It’s was up an otherworldly 46% over three trading sessions, and mystifyingly so.
It’s a headscratcher on a couple of levels. One, that a central bank is publicly listed at all. The BOJ is on the Tokyo Stock Exchange’s Jasdaq board, making it part of a rarified group that includes Belgium, Greece and Switzerland.
A bubble within a bubble
Another is with negligible dividends and no voting rights, what’s the point? Yet at a moment when Bitcoin is rallying into the stratosphere – never mind joke cryptocurrencies – and anything from animated internet GIFs to footwear are considered asset classes, why not bet on Japan’s lender of last resort and printer of a top-3 currency?
We’re talking, though, about something of a bubble within a bubble. Watching the Nikkei and the S&P 500 Index surge about 70% between the lows of March 2020 and February 2021, “the familiar dynamics of a bubble have become impossible to ignore,” argues Peter Tasker, author and Arcus Investment strategist.
Hiroaki Hayashi, managing director at Fukoku Capital Management, also senses a “similar feel” to episodes of irrational exuberance in the past. Hayashi points to the massive rallies in Bitcoin and GAFAM shares, referring to Silicon Valley giants Google, Apple, Facebook, Amazon and Microsoft, amid a pandemic and trade war.
“The world order,” he notes, “is looking shaky too, as evident in the changing US-China relations.”
The BOJ’s historic liquidity is adding to the disorientation. It’s finding a home in Japanese asset markets, not the real economy. As wages stagnate and consumer prices turn in their weakest performance in more than a decade, the Nikkei is going gangbusters.
On February 15, the Nikkei closed above 30,000 for the first time since 1990.
The benchmark index has since returned to the high mid-29,000s range. Yet even this represents a 42% 12-month return despite a demand-killing pandemic nudging Asia’s No 2 economy back toward the deflation that Kuroda’s Peter Pan-channeling BOJ tried to defeat.
Biggest pyramid scheme in history?
Is the Nikkei once again a bubble sure to burst in 2021? The odds can’t be discounted as the pandemic exposes the bull market in magical thinking, propelling higher a market that’s challenging virtually every rule of financial gravity.
To be sure, historians will look back at the last 12 to 14 months with considerable bewilderment as stocks from New York to Frankfurt to Seoul surged almost as aggressively as the Covid-19 cases devastating the global economic outlook.
“Covid-19 market bubbles, a creation of the distorted global economy, cannot last,” warns economist Andy Xie, formerly Morgan Stanley’s chief Asia economist in Hong Kong.
Keeping things aloft are central bank policies creating the biggest pyramid scheme in history. None tells the story better than Kuroda’s BOJ – or offers a better case study on how to return policies to some semblance of reality.
This falling consumer price trend has its roots in the post-1990 collapse in asset prices.
Japan first became a cautionary tale in the years after the Nikkei’s 1989-1990 fall to earth. As air rushed out of bubbles in stocks and property, Tokyo began rolling out fiscal spending packages that decades on would shackle it with the developed world’s biggest debt burden.
Banks holding mortgages to all too many of those properties were in trouble as debt repayment became impossible.
By 1999, the BOJ had cut interest rates to zero. Two years later, in 2001, then-Governor Masaru Hayami pioneered quantitative easing as deflationary pressures deepened and broadened. Rather than take bold actions to restructure the economy, the government churned out countless fiscal boosts. This pattern is at the root of Japan’s lost decades.
Enter Kuroda in 2013. He was brought on to supersize the BOJ’s monetary easing regimen. Before long, Kuroda’s team had cornered the government bond market, hoarding more than 50% of all outstanding issues. The BOJ loaded up on stocks via exchange-traded funds.
By 2018, the BOJ was a majority shareholder in 40% of all listed Japanese companies. That was the same year the BOJ’s balance sheet topped the size of Japan’s entire US$5 trillion economy, a first for a Group of Seven nation. These powerful easing jolts had driven the yen lower by as much as 30%.
That decline, the BOJ’s historic credit creation and the spillover effects of a rare synchronized global recovery, helped generate Japan’s longest expansion since the 1980s – and record corporate profits. What it didn’t do, though, was boost wages the way former Prime Minister Shinzo Abe had promised.
When the coronavirus hit in early 2020, the costs of Japan’s wage-less recovery became all too apparent. The chaos forced the BOJ to push even deeper into asset markets – and to become even more assertive about driving yields negative.
Yet as the BOJ went even bigger with the stimulus, the vast majority of the fresh firepower flowed into already frothy equities. Property became less attractive as Covid-19 threatened the building boom accompanying a Tokyo Olympics that might not happen. They left stocks as the only wager in town.
At the start of 2020, Nikkei stocks on average were trading about 14 times forward earnings. Today, with economic prospects much darker than 14 months ago, Nikkei price-to-earnings ratios are flying at 34 times projected profits. And doing so despite new headwinds zooming Tokyo’s way.
Abe had the ball rolling
The Nikkei’s surge might make more sense if Abe had gone further in his 2012 to 2020 premiership to internationalize corporate governance. Indeed, he had the ball rolling. Abe introduced a UK-like stewardship code and encouraged companies to give shareholders a bigger voice and add outside directors. In some cases, these steps helped improve average returns on equity.
The good news, says strategist Nicholas Smith of CLSA Japan, is that some shareholders in the broader Topix Index are feeling more emboldened. “No major market has a greater proportion of heavily cash-laden companies than Topix,” Smith says, adding that “39% of Topix non-financials have net cash of over 20% of equity.”
These “egregious capital hoarders got a reprieve from activists due to the pandemic last year – they won’t get that lucky again: this year, investors are likely to be making up for lost time,” Smith says.
The largely voluntary nature of governance upgrades, though, limited their success. The concern for many investors, and not just asset bubbles, relates to so-called “moral hazard.” In other words, that too much central bank money chasing too few good, productive investment opportunities warps incentives or even rewards bad behavior.
It takes the onus off CEOs to cut unprofitable businesses, shake up staff levels and embrace meritocratic pay and promotions and take risks. That has many encouraging the BOJ to recalibrate its purchases accordingly. It also has observers prodding the BOJ to re-evaluate what’s working – and what’s not.
“Given that it will take more time than expected for the economy to recover, it is important for the bank to analyze and assess policy effects with a view to making further sustainable and effective policy responses,” says economist Takeshi Yamaguchi of Morgan Stanley MUFG.
Can the Nikkei stay aloft?
“In terms of yield curve control and purchases of assets such as ETFs, it is crucial for the bank to conduct them more flexibly in a prioritized manner while maintaining the current policy framework.”
In the meantime, punters are wondering if, and how, the Nikkei can stay aloft in 2021. In Tasker’s view, “today’s Covid bubble has many similarities with the dotcom bubble of 20 years ago.”
Tasker notes that the “new frontier is again technological,” driven by the promise of 5G networks, renewable energy, electric vehicles and tensions between winners in the “sharing” economy space and those benefiting from pandemic-related work-from-home disruptions.
“It’s not a whole economy phenomenon, as was the case with the Japanese bubble of the 1980s, but a limited, though powerful mania. That is why many markets in the world, Japan’s included, are not excessively expensive on conventional valuations. Lots of stocks remain earthbound, while the chosen few have ascended to the heavens.”
A key reason, though, for Japan’s chosen status is BOJ policies blurring the lines between economic gravity and Kuroda’s Peter Pan flights of monetary fancy.