Nikkei's March Toward 20,000 Milestone Driven By 'Old Economy'

While still significantly lagging its peers, the Nikkei 225 has reached a 7-year high in moving past 18,000, and is steadily marching ahead toward 20,000, which was last seen in March-April 2000, at the height of the Net/IT bubble.

Domestic strategists and institutional investors are now looking for at least 19,000 within this year. But the biggest difference between the current secular rally in Japan and the lead-up to the 2000 mini-bubble is that Japan’s stock market is now being driven by “old economy”, not “new economy” stocks, particularly those most closely linked to reflation of the domestic economy (like real estate), and to global demand trends such as globally tight supply-demand for steel, shipping capacity and construction equipment.

We believe that the secular bull market in “old economy stocks” will continue. There will be periodic trading rallies in technology stocks, but the competitive environment for Japan’s technology stocks is completely different now than in the lead-up to the Net/IT bubble. Now, Japanese technology companies like NEC (NIPNY.PK) and Hitachi (HIT) are struggling to keep up with the likes of Samsung Electronics. The major exception is Nintendo (NTDOY.PK), whose DS portable and Wii game machines continue to drive very strong earnings growth that is being boosted by renewed weakness in the yen.

Moreover, while the BOJ is widely expected to bump up short-term rates in August, this is already discounted in bond yields, the yen’s exchange rate and even real estate stock prices. Moreover, a 25bps rate hike in Japan is very unlikely to bridge the substantial yield gap between Japanese, US and European rates.

Foreign investors should continue to dominate trading, as they now own some 28% of the total market value of Japanese stocks, and are recently accounting for as much as 60% of daily trading value. A significant amount of this buying momentum is being provided by European (including Middle East oil money) and Asian investors, where pools of investment capital are growing more rapidly than in North America.