Japan's puzzling stockmarket boom
English original of article published by Nikkei Business on March 29th, updated for the Bank of Japan's "historic" decision to move from -0.1% interest to +0.1%
The moment was delightfully symbolic, in a way that was more complicated than many traders might have liked: after gaining more than 20% since the start of 2024, the Nikkei 225 index had finally passed the peak that had been set more than 34 years ago, on the final trading day of 1989, but in the 2024 version it passed that peak immediately after Japan’s national statisticians had reported that the Japanese economy was in a “technical recession” during the final two quarters of 2023 and just as the yen exchange rate was hitting new lows.
The moment was said to be symbolic of recovery and of corporate renewal but that juxtaposition made it also symbolic of confusion and of contradictory indicators about the state of corporate Japan and the Japanese economy. Some of the confusion appeared to be cleared up when Japan’s national statisticians revised their judgement on 2023’s final quarter having found there had been some growth after all. But the sense of there being two Japanese economies, a booming stockmarket one and a rather duller real one, remained.
In reality, such confusion is nothing new. The relationship between stock market performance and the real underlying economy has been a source of amazement and sometimes amusement during the whole of my career as an economic and financial journalist, and not just in Japan.
Often, the fact that share prices have no apparent link to recent economic growth can be explained by saying that GDP statistics always report on the past whereas share prices reflect the market’s predictions about the future. This explanation is true, in principle, but in practice is not very useful: is anyone seriously now expecting an economic boom in Japan or other sudden improvement in the country’s economic fortunes?
Sometimes a stockmarket index contains many companies which sell a lot abroad, making that index a reflection of international economic growth rather than domestic growth. This has often been true of the London stock market, for example. But although the very weak Japanese yen will help export sales for many companies, the prospects for the international economy do not look strong enough to provide an explanation for the strength of the Nikkei or TOPIX.
In truth, there are currently two main competing explanations for how a stock market boom can coincide with slow or even stagnant economic growth in Japan. The explanation favoured by those who are bullish about future equity price rises concerns corporate governance reform and a general re-evaluation by the market of listed Japanese companies. The explanation favoured by those who are sceptical about whether the market boom can continue is the weakness of the yen and the way in which that cheap exchange rate has attracted international investors.
These explanations can certainly both be true at the same time, but what is important is that they carry very different implications about the sustainability of the recent share-price trend and therefore about the future financing of listed companies.
The argument based on corporate governance reform, on pressure to raise prices above book value, and on generational change in company managements is certainly convincing. One reason why it convinces a macroeconomic analyst such as myself, in fact, is precisely that it focuses attention on the behaviour of a particular segment of the economy – large, publicly listed companies – rather than on the whole economy or the whole of corporate Japan. As a result, we can understand the new highs in the Nikkei and TOPIX indices as representing the exceptional performance of a group of companies rather than purporting to represent the whole Japanese economy.
What is true, in addition, is that the end to zero interest rates that the Bank of Japan announced on March 18th also has important implications for the future role of the financial markets in allocating capital between productive companies and less productive ones. The long period of zero interest rates partially suspended or at least weakened that allocative function, and it is correct now to expect this very important allocative function is to become stronger again. But only gradually: the official rate has only been raised from -0.1% to +0.1%, which remains negative after adjusting for inflation. The direction of movement can be counted as historic, for not yet its speed or extent.
As an outside observer I still have to ask myself for how long these forces can really continue to provide such remarkable rises in share prices. This is why the argument based on the yen exchange rate is important: foreign investors have been attracted to the Tokyo stock exchange also by the fact that Japanese assets look very cheap in US dollar terms, and, crucially, by the prospect that a recovery in the yen’s value will deliver those investors a further capital gain.
That recovery in the yen is likeliest to occur when the difference between the Federal Reserve’s interest rates and those set by the Bank of Japan starts to narrow. Most probably, that means in the middle of 2024, when the Fed starts cutting interest rates and the Bank of Japan starts to raise them.
At that point the two forces which have complemented one another to generate the new peaks in Japanese share prices will start to push in opposite directions. We will then learn which of the forces was the most powerful. All share price booms come to an end eventually: the only question is when.