Japanese Stock Market Will Underperform

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Japanese bond yields and dividend yields are converging.

Japan's dire fiscal situation is a drag on Japanese stocks.

Japanese declining consumer confidence is a leading indicator for a drop in the Japanese stock market.

If you want ideas which investment to make in the coming months, I would expect a decline in the Japanese stock market.

First, we note that the 10 year Japanese bond yield at 0.6% is pretty competitive against the dividend yields of Japanese stocks at 1.8% (Chart 1). So stocks aren't such good value anymore compared to a year ago when dividend yields were at 2.8% compared to a 10 year treasury yield of 0.7%. Dividend yields and bond yields are now converging towards each other. Moreover, the P/E ratio of Japanese stocks is currently at 13, which isn't particularly cheap.

Chart 1: Japan: Dividend yield Vs. Treasury Yield

Secondly, I have written extensively about the dire fiscal situation in Japan. Japan has a current account deficit, is printing money to stimulate their economy and more and more of its interest payments on Japanese debt is financed by less tax revenue. Obviously, this won't be bullish for Japanese stocks.

But most importantly, recent numbers on the consumer confidence in Japan, point to a decline in the stock market for the coming months.

At the start of 2013, consumer confidence in Japan had a boost and this made the Nikkei surge almost 50%. But since 2014, consumer confidence has collapsed to even lower levels than in 2013 (Chart 3).

So I expect that the Nikkei will follow in this steep decline in the next months (Chart 2).

Chart 2: Nikkei

Chart 3: Japan Consumer Confidence

On a side note, we identified a correlation between consumer confidence and the stock market: Consumer Confidence Vs. S&P. From this correlation we know that consumer confidence is a leading indicator for the stock market (S&P) and this theory can also be applied to the Japanese stock market. All will depend on the trend of Japanese consumer confidence going forward, so investors need to monitor this trend.

To bet on a decline in Japanese stocks, investors could buy shorts on the Nikkei with ProShares UltraShort MSCI Japan (NYSEARCA:EWV).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.