Note from dshort: I updated this commentary last week, when Japan's Nikkei 225 was up 73.8% from its interim low in November of 2011. Guess what! A mere four trading sessions later, it's up 81.2%. After months of discussion and press speculation, last month the Bank of Japan disclosed its radical redo of monetary policy. The index is up 19.6% since the day before the unveiling on April 4th.
What about Japanese government bonds? The closing yield on the day the Nikkei hit its interim low on November 25, 2011 was 1.53%. While the index is up 81.2%, the 10-year yield is now at 0.74%.
Here's a quick review of the Nikkei 225, the 10-year bond and inflation over the past few decades.
The table below documents the advances and declines and the elapsed time for the major cycles in the Nikkei.
The Nominal versus Real Nikkei 225
For most major indexes, we expect to see a significant difference between the nominal and real price over a multi-decade timeframe. But Japan's chronic bouts of deflation have kept the two metrics rather tight. Note that I've used a log vertical axis for the index price to better illustrate the relative price changes over time.
Japanese Bond Yields: How Low Can They Go?
Government bond yields in many safe-haven countries have plunged since the Financial Crisis, although the US 10-year, now hovering around 1.9 percent, is well off its historic closing low of 1.43 percent set in July of last year. The lesson from Japan is that the trend toward lower yields can last a very long time. Here is an overlay of the nominal Nikkei (linear scale) and the 10-year bond along with Japan's official discount rate. The 10-year yield hit its all-time low in June of 2013, about 10 years ago, at 0.43%. It closed tiday at 0.74%.
And here is a closer look at the 10-year yield over time (linear scale).
I mentioned that 10-year record low of 0.43%. When the latest round of BOJ easing was officially announced on April 4th, the yield closed that day at 0.44 percent.
The consensus view of the Nikkei's massive rally since last November, and certainly one that I share, is that it is essentially a result of the market's response to rumors and news of the BOJ's plan for the latest easing of last resort months before its implementation, with the falling Yen as the key driver.
Interestingly enough, today Japan's finance minister, in typical fashion, distanced monetary policy from market performance.
What we're seeing in Japan is a new chapter in an amazing drama of economics and the market -- one that will no doubt have additional chapters of interest in the not-to-distant future.
Note: The "recessions" highlighted in the third chart above are based on the OECD Composite Leading Indicators Reference Turning Points and Component Series. I use the peak-to-trough version of data (peak month begins the gray, trough month is excluded), which is conveniently available in the FRED repository. As we can readily see, the OECD concept of turning points is much broader than the method used by the NBER to define recessions in the US.