What next for the Nikkei?

An erstwhile top performer, Japanese shares are so far down 10% since the New Year
Japanese shares were the best-performing major market since Shinzo Abe’s election, up 86 per cent as the Nikkei Dow turned in its best annual performance since 1972. The spectacular performance of the Japanese stock market was powered by the three arrows of Abenomics — fiscal largesee, epic monetary stimulus by the Bank of Japan and structural reforms in energy, trade, taxation and agriculture. However, I believe the easy money in the Japanese stock market has been made in 2013.

Japanese shares are down 10 per cent since the New Year as the yen has risen from 105 to 101 on risk aversion in emerging markets, China PMI softness and safe-haven capital flows. In fact, the Nikkei Dow has underperformed India, Indonesia and even Turkey in 2014.

As I write, the Nikkei Dow is 14,300 and the Topix is just below 1,200. Kuroda-san’s latest loan facility convinces me that there is a BoJ “put” on the Nikkei Dow, since the central bank of Dai Nippon will do its best to expand the monetary base and depreciate the year if economic growth remotely slows, as it did last month. In fact, the divergent monetary policies of the US Fed and the BoJ is the major reason I am a strategic buyer of every swoon in dollar/yen below 102. Haruhiko Kuroda now manages the world’s most-aggressive central bank quantitative easing programme relative to GDP.

So while I am no longer a beta jockey/maximum bullish on Japan, I believe the Nikkei Dow correction is one that will be painful, but not catastrophic. My buy/sell range for the Nikkei Dow is now 13,000-17,000. My Japanese yen range is 98-108.

Japanese stocks are not expensive at 14 times earnings, with EPS growth momentum attested by the recent earnings of Toyota, Hitachi, Sony, Nissan, etc. I am stunned by the spectacular opportunities I see in potential triple-bagger reflation/construction sensitive small caps. As the Chicago Volatility Index rises above 15, GDP growth is mediocre, bloody riots engulf Ukraine, Turkey, Thailand, Egypt etc, there is every reason for the yen to rise to my 98 target. This means there is another 1,500-point devonside risk in the Nikkei Dow since Japanese equities cannot rise with stronger yen. However, I doubt if the BoJ will allow a rise beyond 98 against the dollar.

There are two major risks to the Japanese economic scenario: Will the LDP government be able to enact structural reforms to offset the fiscal drag of the consumption tax? Will Abe’s Yasukuni Shrine visit and nationalist stance on the Senkuku Islands lead to deteriorating relations with China at a time when the Beijing politburo also uses nationalism and the horrific wartime memories of Manchuria/siege of Nanking to generate mass legitimacy at home and appease the generals of the PLA?

Japan is one of the world’s most-vulnerable societies, as the Fukushima nuclear tragedy, the 2011 tsunami and earlier North Korean missile threats attest. Japan is also the only country in the world where the demographics are so awful that the adult diaper market is bigger than the baby diaper market. There are entire villages in Hokkaido populated by men and women born before the mushroom cloud vaporised Hiroshima and Nagasaki.

The Japanese growth scare will peak in April when the sales fax will rise from five to eight per cent at a time when real wages are static. This means GDP growth could fall to one per cent or lower and the malign ghosts of the two lost decades could resurface. So far, gaijin investors, not Japanese life insurers or pension funds, have fuelled the speculator Nikkei Dow rally since late 2012. However, I believe Japan is in a secular bull market. So if the Nikkei Dow falls to 13000, the Japanese investors will finally buy en masse. The hoofbeats of the Tokyo pension funds herds will trigger the next bull run in the Nikkei Dow as long as the BoJ does not allow the yen to appreciate above 98.