Japan’s shrinking monetary base (with recent declines of 20% per annum), while once a serious concern by economists and market strategists, has proven to essentially be a non-event. These funds were never recycled into the real economy or indeed Japanese financial markets, despite claims to the contrary. The reality is that Japan’s economy continues to reflate, as evidenced by the first rise in nationwide property prices in 16 years.
The real head-scratchers in the Japanese market are why foreign investors continue to buy JGBs at ridiculously low coupons, and why domestic institutions remain structural net sellers of Japanese equities as well as foreign currency-denominated securities.
Foreign investors are expected to remain, the major drivers of Japanese stock prices. However, an interesting twist in foreign buying has developed over the past year. North American investors have ceased to be the biggest buyers of Japanese equity, and were replaced by European investors after the June 2006 sell-off, only to be replaced by Asian investors from February of this year.
Next to foreigners, Japanese individual investors account for the bulk of stock exchange trading values. The vast pool of individual financial assets in Japan (JPY1.5 quadrillion and counting) is large enough to support BOTH increased investment in Japanese equities and active investment in foreign currency -denominated investment vehicles, including high yielding and higher risk foreign currency-denominated equity funds.
The upward trend in Japanese property prices is just getting started, as it has lagged the beginning of the secular bull market in stocks by nearly four years. This implies there is more upside potential in property-related Japanese stocks, even though stock prices in the sector in some cases have already quadrupled.
On the other hand, a not-that-well-known global expansion play is Japanese shipping and shipbuilders, as there remains a structural shortage of shipping capacity, especially for raw material carriers, that could persist until 2009.
Disclosure: The author remains long EWJ