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We are a team of economics professors in the NY area with a passion for financial markets. In our blog "BubbleBustInvesting.com", we write about individual stocks as well as macroeconomics events. We believe that most of the returns in financial markets can be made during the blow and... More
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  • Don't Bet on a Robust Japanese Recovery 0 comments
    Apr 9, 2011 6:06 PM
     Rational or Irrational Exuberance over Japanese Stocks?

    As reflected by the precipitous slide in the Nikkei Index, Japanese stocks have been out of favor for more than two decades. Following the disastrous earthquake of March 11, this has changed, however.  In a cover story on March 19th issue, Barron’s prompted investors to buy Japanese stocks now, to take advantage of the country’s reconstruction boom, while a week later, mutual funds and ETFs investing in Japanese equities reported an $1.5 billion inflow.  Is this exuberance about Japanese stocks rational or irrational? 

    The answer to this question depends on the comparisons made between the March 11th earthquake and previous disasters. When comparisons are made with the earthquake of 1923 that leveled most of Tokyo, and the disaster of the Second World War that left most Japanese cities leveled this exuberance is rational, as the disasters changed economic fundaments, especially policy. Both disasters prompted policy makers to ease monetary and fiscal conditions that fueled an expansion in the aggregate demand, especially a construction boom that boosted equity prices, especially shares of companies involved directly or indirectly in reconstruction. 

    When comparisons are made with the disaster that followed the 1995 that hit the Kobe area, this exuberance is irrational, as the disaster didn’t change economic fundamentals. Monetary authorities did little to stimulate aggregate demand, because they were in a dire situation: they had driven short-term rates to near zero to fight deflation. Fiscal authorities weren’t in better shape either, as they were building bridges to everywhere and nowhere! Stock market gains, as a result were short-lived. After retracing its 25 percent decline in the next twelve months since the earthquake hit, the index continued its decent to new lows.  

    Policy makers are in even more-dire situation at the time the March 11th earthquake hit. Thanks to several rounds of quantitative easing both short-term and long-term rates have hovered near zero levels for a prolonged period of time. This means that investors who buy into Japanese stocks now shouldn’t expect a boost from lower rates, and a boost from fiscal policy should be minimal, as money is expected to shift from building bridges to nowhere to repairing bridges to somewhere. Government’s hand to spend freely on infrastructure is further constrained by the country’s heavy debt burden that approached 200 percent of the GDP before the disaster.

    Follow our blog on stocks and the macroeconomy at BubbleBustInvesting.com and www.twitter.com/bubblebustinv 
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