I have seen many bull markets develop in places where the crowd is least expecting them and I have also seen them develop in ways that elude the untrained eye. It appears the a cyclical bull market in Japanese equities has kicked into gear and is gaining momentum.
Traditional market analysis is based on analyzing the behavior of major market indices like the S&P 500, Dow, and Nikkei. However, as I have discussed on many occasions before, these indices provide a very narrow representation of the behavior of the stock market. Furthermore, at cyclical bottoms, they tend to lag the behavior of smaller capitalization issues, and at times of cyclical tops, the average listed stock usually falls out of its bullish tree well before the major market indices do.
To gain an edge over everyone else, you must look at markets from a very different perspective from everyone else. This is why we developed our own proprietary stock market indices. The objective of the Proprietary Indices is to filter out random noise from the market in order to make it relatively easier to discover the primary trends of stock markets. We have found that broad equally-weighted indices of stock markets are considerably less noisy than traditional major market indices. Furthermore, they tend to be a leading indicator for major market indices at important turning points.
Turning to the subject matter of this article, Japanese equities, the most widely recognized Japanese stock index is the Nikkei. It is essentially a price-weighted index of the most liquid 225 stocks trading on the Tokyo Stock Exchange. However, there is a lot more to the Japanese stock market than the Nikkei and the TSE.
There are six securities exchange markets in Japan: the Tokyo Stock Exchange [TSE], Osaka Stock Exchange [OSE], Nagoya Stock Exchange [NSE], Sapporo Stock Exchange [SSE], Fukuoka Stock Exchange [FSE], and the JASDAQ.
The JASDAQ is the only one specialized solely in venture firms and small capitalization stocks. Other Japanese exchanges created “sections” that specialize in “small cap” stocks such as the TSE’s Mothers exchange and OSE’s Hercules exchange.
Of the 750 IPOs in Japan between 1998 and 2010, 48 percent were listed on JASDAQ. The other 52 percent were listed on Mothers, Hercules, TSE, and other markets. At the end of 2010, the number of listed companies on the following Japanese securities exchanges were approx: TSE1 (1,700), TSE2 (450), OSE1 (650), OSE2 (250), Hercules (170), Mothers (180), and JASDAQ (950). Note that some companies are listed on more than one exchange.
Now getting back to my original "thesis" that to gain an edge on everyone else you need to look at markets from a different perspective. Instead of focusing on the Nikkei which is still trading below its April 2010 high:
Nikkei 225 Stock Index
Why not look at the behavior of the more speculative or economically sensitive growth stocks of the JASDAQ exchange? Note from the JASDAQ Index chart below, the trends in the behavior of the JASDAQ are far less subject to noise than that of the Nikkei! Also note the formation of what appears to be a long term bottom.
JASDAQ Stock Index
Now the problem with the JASDAQ Index is that it is dominated by just 3 companies (Yahoo, Rakuten, and Jupiter) which account for 35% of the index. However, if we take all the components of the JASDAQ Index and equally weight them a rather different story emerges. Our Proprietary JASDAQ Index is already trading at multi-week highs!
Proprietary JASDAQ Index
And below is the same Proprietary Equally Weighted JASDAQ Index from a shorter term perspective (last 12 months). Note the powerful up trend that has got underway. Also note that while the Nikkei has pulled back over the last 10 days the Equally Weighted JASDAQ has continued to move higher.
The behavior of the Equally Weighted JASDAQ index suggests that the "average" listed stock in Japan is engaged in a materially stronger bull trend than the major averages (like the Nikkei or even TOPIX) are suggesting.
Yes, it really does appear that something big and bullish is developing in the Japanese stock market. Given that the median price to book ratios of stocks on the JASDAQ is 0.75x and for the Tokyo Stock Exchange 0.88x, and respective dividend yields of 2.0x and 2.2x (which are light years ahead of the pathetic 1.3% you get for 10yr JGBs) I think that there is considerable upside potential, or if I am a little too early then very limited downside from current levels.
Disclosure: I am long JOF, EWJ.
Additional disclosure: Long LEAPS Calls on EWJ
