The Nikkei Stock Average closed 128 points higher, or 0.9%, to close the week at 14,612 following the dramatic 7.3% sell-off on Thursday, May 23, 2013. The Tokyo Stock Price Index (TOPIX) also added 6 points, or 0.5%, to 1,194, following a 6.9% sell-off on Thursday, May 23rd.
We think the sharp decline of the Japan equity market on May 23rd was a temporary adjustment following a period of large gains and rapid appreciation. Since mid-November last year, we have seen strong appreciation of the equity market and a falling Yen. After the announcement by the Bank of Japan (BOJ) of its aggressive monetary easing, which it referred to as being “on a different dimension”, in early April this year, long-term interest rates have risen and the bond market has become volatile.
Basically, we believe this adjustment occurred while the financial markets were looking for some equilibrium between stock prices, currency exchange rates, bond yields and the real economy. Assuming that rising stock markets and the weaker Yen are a reflection of higher inflation expectations and growth potential, higher long-term interest rates would not be unreasonable.
However, the Japan equity market was no longer undervalued relative to its global peers from a PER (price-earnings ratio) perspective before the May 23rd sell off. It is reasonable to assume that higher long-term interest rates became a trigger for this valuation adjustment in the Japan equity market.
Possible scaling back of the quantitative easing (QE3) by the Federal Reserve has led to higher interest rates in the U.S. Higher interest rates or weaker bond markets worldwide tend to have an impact on the stock market.
On the global foreign exchange market, the U.S. dollar (USD) has been appreciating not only against the Yen but also against other currencies, partly because many other developed countries are following similar quantitative monetary easing policies to those implemented by the BOJ and the Federal Reserve Bank.
The strong USD has a restrictive effect on economies with currencies that are linked to or have strong correlation with the USD. Countries with current account deficits, such as emerging economies, or natural resource producing countries, have seen weaker stock markets and currencies.
It is not likely that the Yen will continue to depreciate in isolation from here. In summary, the effect of the first arrow of Abenomics (aggressive monetary easing) has almost been discounted in the financial markets and in the relationships among different asset classes and global markets.
From now on, the Japan equity market will be more heavily influenced by the global investment environment. We are now monitoring the growth strategy aspects of Abenomics, the so-called “third arrow”. The market now expects the government to show more progress in specific policy areas, such as the Trans-Pacific Partnership (TPP) negotiations and a package of structural reform measures scheduled to be announced in mid-June.
At the same time, we are paying attention to the conditions for individual companies and how they are taking advantage of improving economic conditions to carry out structural reforms. Individual stock selection will become even more important in Japan equity investment management. We aim to identify investment opportunities by selecting companies that can capitalize on the improving macroeconomic environment to enhance their competitive edge.
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The Nikkei 225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. The Tokyo Stock Exchange Price Index (TOPIX) is an unmanaged capitalization weighted measure (adjusted in U.S. dollars) of all shares listed on the first section of the Tokyo Stock Exchange. One cannot invest directly in an index or average.
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