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While the phenomenon hasn't received much attention, the Nikkei 225 headline Japanese stock index has diverted course from all other major economic player stock exchanges. The Nikkei turned negative on August 14, 2009 and hasn't been able to resume the congruent pattern that all other major stock market indexes seem to be following. One can notice the sharp downward shift of the red line, representing the Nikkei 225 index, amidst all other global stock markets rising to new highs.

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In mid August, just as the Nikkei began to falter, the "old guard" LDP (Liberal Democratic Party) turned in the keys, having lost the general election by a landslide, and now the contending DPJ (Democratic Party of Japan) finally has the reigns. The LDP had been in control during every year but one since the beginning of Japan's post-war government, and the DPJ has inherited more than a few liabilities.

Japan is facing unemployment that peaked at 5.7% in August and has since receded to 5.3% in the latest October reading, still historically high by Japanese standards. But what's really hurting Japan is the deflation problem, only recently admitted by the BOJ (Bank of Japan), which sites consumer prices excluding food at -2.3% yoy (year over year). The debt of the nation sits just shy of 200% of GDP in an era where dwindling numbers of offspring forewarn of a mass scale government revenue shortage. The National Institute of Population and Social Security Research predicts that current trends will force Japan to contend with a 30% population decrease by 2055 (less than 90 million people and roughly equal to the 1955 tally) where the number of citizens under the age of 65 will fall in half.

So has Japan's stock market fallen because its currency has declined since August, causing for the opposite effect that the dollar is having on U.S. equities? One of my favorite professors described it best saying, "as it turns out... maybe". In the chart below you'll see that the Japanese Yen turned more expensive relative to the dollar early in August, but so did every major currency included in the above chart citing national equity index performances. After all, the Japanese Yen was the big brother to the Dollar as a preferred carry trade currency and was used to fund a plethora of risky bets under previous LDP low interest rate policies.

Currency 11-24-09

The new JDP administration is walking into a shrinking population, deflationary currency environment, historically high unemployment, 200% x GDP debt, 3% GDP stimulus spending and only 1.2% growth in the third quarter to show for it thus far. It must be increasingly uncomfortable for Japanese Prime Minister Hatoyama and rightly excruciating for BOJ Governor Shirakawa. The prime minister is promising a boost of costly public services, handouts and tax cuts to the struggling consumer base while Shirakawa vows to keep rates low when speaking to the G20.

Investors are exiting Japanese stocks because as things stand the Japanese government won't make good on debts and the only reasonable outcome will be for Japanese stimulus to be withdrawn early. In the alternative situation, Japan default on debts and create extreme problems for the nation and Japanese corporations in the future. Some blame the threat of deflation amidst global asset appreciation for the Nikkei's recent misfortune, yet the truth of the matter shows an indebted nation spending more and making less in an environment where global recovery is not a strong enough sell to stay long firms headquartered therein.

While U.S. regulators see what is unfolding in Japan, a blind eye is turned and the wallet comes out. After all America is a nation of winners, where the adverse scenario to the stimulus not working before our own debts come due is just too dark for a "#1 Nation" to acknowledge.

Disclosure: Long SDS, Long TYO

Source: Nikkei Nosedive: Signals from a Weak Japan