J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 48
Tuesday, October 14, 2003
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++ Viewpoint: What is the Bank of Japan up to?
The Bottom Line:
Top-Down: Under the zero-interest-rate policy, "sterilized" and
"unsterilized" intervention in the currency market produce the same
o The Bank of Japan's surprise move appears to be a change of
tack aimed at several monetary policy goals.
o But under a zero-interest-rate-policy regime, the monetary
base and short-term government bills are almost complete
substitutes. This means that: a) "unsterilized" currency
market intervention has essentially the same impact as
"sterilized" intervention on the exchange rate, and b) the
increased current account balances have have no economic
effect, as they play no part in the creation of credit.
o The bottom line is that foreign exchange traders are correctly
assuming that despite the new tactics, the Bank of Japan is
effectively giving them a green light to trade the yen higher.
* Bottom-Up: What the foreigners giveth, they can also taketh away.
o Aggressive buying by foreign investors has provided the only
buying demand for Japanese equities since April, leaving
Japanese stock prices very susceptible to a change in
perceptions by foreign investors.
o Essentially, what the foreigners giveth, they can also taketh
away. Also, the assumption of continued yen appreciation means
that the export-related, international blue chips will
continue to underperform the Topix on a relative basis until
the top in the yen is confirmed.
o Conversely, Japan's small-cap stocks continue to mark new
rebound highs, ostensibly because of still active individual
investors (day traders) buying stocks from the second section
of the Tokyo Stock Exchange and Jasdaq that are not subject
to "daiko henjo" (companies selling equities in order to
return part of their pension plan to the government) by the
domestic corporate pension funds, and the shifting relative
value perceptions of foreign investors.
o In addition, mining stocks have been outperforming the Topix
as a whole, reflecting sharp gains in: a) the underlying
global precious metals and industrial metals markets, and b)
the mining and nonferrous sectors in the US market.
Ironically, the best performing stocks in the sector have the
weakest balance sheets, in keeping with one pattern of this
rally, where the buying tide is especially favorable for the
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++ Viewpoint: What is the Bank of Japan up to?
After using over 13.5 trillion yen in an effort to keep the yen
from appreciating, the Bank of Japan (BOJ) apparently has changed
tactics. On Friday of last week, it made a surprise and unusual
decision at its Policy Board meeting to ease monetary policy further
by raising the upper limit on the target of current-account deposits
by 2 trillion yen to 32 trillion yen for a new range of 27-32
trillion yen. This is the first easing of its policy in nearly five
What is the BOJ up to? Just weeks ago, bank governor Toshihiko Fukui
was denying there was a need for such steps. The stock market
evidently liked what it saw in the BOJ policy move, while the yen shot
up to about 108 to the US dollar, or well above the 115-yen level the
BOJ had fought so hard to maintain with massive currency market
interventions to date.
The BOJ action appears aimed at several policy goals:
1. The bank wants to offset the deflationary impact of a
stronger yen, which works to reduce GDP growth as well as
corporate profit growth.
2. The bank hopes it can keep a lid on the spike in long-term
bond rates and show the markets they are as committed as ever
to maintaining their quantitative easing measures.
3. Since the Group of Seven pronouncements have apparently
made it more politically difficult to aggressively intervene,
the BOJ appears to be trying a different tactic, as inevitably
the stronger yen will elicit howls of protest from
corporations and their supporters in the government.
But economists have long maintained that currency market
intervention, particularly "sterilized" intervention, does not
work if the economic fundamentals do not support it. Moreover,
there is essentially no difference between "sterilized" and
"unsterilized" intervention under a regime of zero-interest-rate
policy. The level of the yen, under sterilized or unsterilized
intervention, is only relevant to the extent that the level of the yen
is a function of interest rates. But the monetary base (defined as
bank notes and coins in circulation plus current account balances at
the BOJ) and short-term government bills are almost complete
substitutes under the zero-interest-rate policy. Thus it makes
no difference whether the intervention is sterilized or not.
Foreign exchange traders correctly assumed that by changing tactics,
the BOJ was giving them a green light to trade the yen higher. This
makes us even more convinced that the Japanese yen is heading through
the 100-yen level and could very well challenge its prior high of 79
yen to the dollar.
By the same token, the amount of clearing balances at the BOJ have no
economic effect, as they play no part in the creation of credit. The
BOJ is just pushing harder on the same string it has been pushing on
all along, given the current liquidity trap.
There may be several trillions of yen sloshing around in the BOJ's
current accounts, but precious little will find its way into the real
economy unless the banking sector can resume its traditional role of
being a money multiplier for the economy. News that Resona Bank is
aggressively moving to pare down its nonperforming loans with a
massive 1.79-trillion-yen write-down is encouraging news, but the rest
of the banking sector needs to follow suit. The BOJ has actually done
little other than stand on the sidelines and give the stock
market a good "gambatte" cheer.
The Foreign Factor
Foreign investors have yet again given Japanese equities a very
welcome rally. Since April of this year, foreign investors have
been net buyers of Japanese equities by 5.3 trillion yen, according
to Tokyo stock exchange statistics (Finance Ministry statistics show
6.9 trillion yen of net buying).
At the same time, they have been net sellers of Japanese government
and corporate bonds by some 3.22 trillion yen, indicating that some
yen asset switching from bonds to equities has taken place.
But foreign investors have been virtually alone in their bullish
stance on Japanese equities. During the April-September period,
domestic investors have been net sellers of Japanese equities by 5.2
trillion yen, including 2.4 trillion yen of net sells by the trust
banks, 820 billion yen by individuals and even some net selling by
the brokers on their prop accounts.
When foreign investors first became net buyers of Japanese equities in
April, there was a strong feeling that Japanese stocks had
significantly lagged behind the global rebound in equities. The last
couple of weeks, however, have seen a subtle change in aggregate net
buying by foreign investors. During the third week of September,
foreign investors turned net sellers of Japanese equities for the
first time in 24 weeks, and the Nikkei index promptly dropped 7.4
percent from a high of 11,033 on September 19.
Time for Increased Stock and Sector Selectivity
Because the yen could well continue appreciating despite the BOJ's
efforts, Japan's export-oriented, international blue chips will
continue to underperform on a relative basis. Thus, such stocks should
be avoided until the yen's appreciation peaks.
Conversely, both the Topix 2 and Jasdaq have outperformed the larger
indexes during this recovery and should continue doing so. It is in
the small stocks where individual-investor buying can have the most
favorable impact, as there is less volatility from cross-holding
unwinding by domestic institutions on the one hand, and possible
foreign-investor selling on the other.
In addition, Japanese stocks often take a hint from trading trends
in the US market. During the past three months, the best performing
sectors in the Dow Jones US indexes have been mining and nonferrous
metals, as investors have switched gears and are now trying to
discount inflation, not deflation, and continue to expect a weaker US
Over the past three months, selected mining and nonferrous metals
companies have also been outperforming Topix, including Furukawa,
Nittetsu Mining, Mitsui Mining and Smelting, and Mitsubishi Materials.
Ironically, one pattern seen during the current rally in Japanese
stocks has been that the companies with the weaker balance sheets have
out-performed their peers. This we see as a reflection of a more
sanguine view of bankruptcy risk. That said, balance-sheet quality
still matters, especially after the current overly bullish market
sentiment in Japan fades. Thus, while it may mean forfeiting some
short-term relative performance, we continue to believe that the
"quality" stocks (i.e., those with a sound balance sheet) will in the
-- Darrel Whitten
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