The Nikkei's New Helicopter

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Summary

  • The BOJ has unleashed one of the most aggressive stimulus packages the world has witnessed. A less reported component is ¥6 trillion in annual ETF purchases.
  • The Nikkei-225 is a price-weighted exchange similar to the structure of the DJIA. The BOJ inflows to the Nikkei have created predictable trading and market anomalies.
  • BOJ inflows have created a buy-the-flow mentality among traders and asset managers at the expense of buying traditional fundamentals such as earnings and organic growth.

As we know, Prime Minister Shinzo Abe launched a ¥28.1 trillion stimulus program in the closing days of July. New government spending came to ¥6.2 trillion, of which ¥4.6 trillion was front-loaded into the current fiscal year, which kept the Japanese economy for the 2nd quarter from contracting. The fiscal component, roughly ¥5 trillion to be spent on various infrastructural projects, caused government bond yields to surge up 23 basis points within days of the announcement for the biggest jump in three years.

Another somewhat less widely reported component of the package was the BOJ's doubling of its direct ETF purchases that specifically track the Tokyo Stock Price Index (MUTF:TOPIX), the Nikkei 225 Stock Average and the JPX-Nikkei Index 400 (JPX-Nikkei 400). The annual program purchasing cap went from ¥3.3 trillion to ¥6 trillion. A mandate to purchase stocks either directly or passively on national exchanges is relatively unique among developed world central banks. The Swiss National Bank is the only other central bank that directly holds equity positions which through the end of the 2nd quarter amounted to 20% of its balance sheet.

The Nikkei Exchange lists 225 companies. As does the Dow Jones Industrial Average (DJIA), the Nikkei is a price-weighted exchange and employs a divisor to determine the value of the index at the close of every trading day. In this manner, a component company with a share price of $100 carries a weight in the index that is 10 times that of a company with a share price of $10, irrespective of market capitalization. For the DJIA, the 3M Company (NYSE:MMM) currently holds the largest weighting in the index at 6.67% with a market share price of $175 through Thursday's market close. Apple (NASDAQ:AAPL), with the largest market capitalization in the world at $555 billion, closed at a share price of $103 and claimed a 3.91% weighting in the Index for the trading day. Similarly, Fast Retailing (OTCPK:FRCOY) holds the top spot on the Nikkei with a stock price of ¥36,330 with a market cap of just over $37 billion. Toyota Motors (NYSE:TM), with a closing stock price of ¥6,171 is one-sixth of FRCOY's weight in the Index, even though its market capitalization is almost $204 billion through Friday's market close.

Adding to the confusion, the Nikkei divisor was revised upward on the 29th of August to 26.008 from 25.596 with the addition of Familymart UNY Holdings (OTCPK:FYRTY) to the Index.

The Topix Exchange lists over 1,700 stocks, and is broad market-cap based index that is calculated by market value with the largest component company holding the largest weighting in the Index. In this manner, the Topix mirrors the S&P 500 index. Accordingly, Apple holds the highest weighting in the Index at 3.05%, followed by Microsoft (NASDAQ:MSFT) at 2.385% and Exxon Mobil (NYSE:XOM) at 1.951% of the S&P Index. On the Topix, top honors go to Toyota, Mitsubishi UFJ Financial (MTU) and SoftBank (OTCPK:SFTBF).

Enter the daily purchasing power of ¥23 billion coming from the BOJ and you get a picture of the market distortion being created, particularly on the Nikkei price-weighted exchange. For a variety of good reasons that are not difficult to discern, the BOJ does not engage in stock picking or pursue strategic investment interests. They avoid bank shares or other financial companies they either directly or indirectly regulate. They hold the companies passively. The shares purchases are not concentrated in any one industry and do not exceed total market value of any given industrial or service sector, while adhering to the weightings of whatever index in play.

The resulting market anomalies are predictable. Companies with high share prices, and thus high Nikkei weightings, will receive more inflow than might otherwise be justified by the dictates of supply and demand under normal market conditions. Obversely, low share prices could garner less inflow than their relative size in the overall market. Companies that split their shares, for example, are clearly disadvantaged. The impact of the BOJ's mandate is dizzying when you consider the math. Say there are roughly 240 trading days, compensating for national holidays throughout the course of the year. At ¥6 trillion, on each of those trading days, the BOJ is committed to buying roughly ¥25 billion just to keep pace for the year. The unsettling premise being implied appears breathtakingly simple: traders are not buying traditional fundamentals - they are buying BOJ fund flows. The effect is likely the closest example of so-called "helicopter" money we have seen in the developed world to date.

Consider translating the BOJ's stock purchasing mandate to US shores. The BOJ's ¥25 billion daily purchase program translates to about $244 million of extra liquidity flooding the equity exchanges. On the DJIA, Fed purchases would likely take a similar passive role, buying baskets of stocks that closely track the weightings of the Dow, or whatever index is in play. Accordingly, companies like 3M, Goldman Sachs (NYSE:GS), IBM (IBM) would be well represented in ETF baskets. For the Nasdaq Index, Apple, Microsoft, Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB) would all be heavily in play. With the S&P 500 Index, Apple, Microsoft, Exxon Mobil, Johnson & Johnson (NYSE:JNJ) and Amazon make up the mix. Cross referencing the three exchanges and certain stocks begin appearing more than once: Apple would dominate the purchasing process for no other reason than the company is a component member of each of the exchanges. Amazon, Microsoft, Exxon Mobil and Facebook are placed high on two of the three exchanges. Asset appreciation would be geometric on the upside - and equally geometric on the downside when the Fed music stops.

BOJ has purchased ¥9 trillion of ETFs since 2012. The barrage of stimulus pumped into the Japanese financial system for the past four years has contributed heavily to the Nikkei Average surging from a low of 8,390 on the 6th of January 2012 to 16,965 through the 9th of September 2016 - a gain of just over 102%. The BOJ's new ETF purchase program is 67% of that total ETF value purchased to date - now collapsed into the space of a single year. The BOJ already owns about 60% of total ETF assets, according to recent Morningstar estimates. And this is on top of the BOJ owning about a third of Japan's outstanding government bonds. The BOJ's current LSAP program is purchasing ¥80 trillion in government debt annually - a pace that is roughly twice the rate of government issuance of new debt. According to Deutsche Bank estimates, Japanese banks hold an estimated ¥94.7 trillion of Japanese debt with maturities of over a year through the end of March. They use about ¥30 trillion for collateral purposes, which leaves about ¥64 trillion available for sale. Add all of this up and you get about 18 months left of available debt for purchase.

The following list highlights companies that list both on the Nikkei and a US exchange and have outsized gains since the BOJ announcement on the 29th of July. While some of the companies benefiting from the BOJ largely hold American Deposit Receipts through US banks or other forms of US bank sponsorship, the overwhelming majority holds no sponsorship at all and list on the US over-the-counter market.

Figure 1: Selected Nikkei Components with dual US Listing

Company

Ticker

Exchange

Industry

Stock Price(9 Sept)

(¥)

Asahi Glass

(OTCPK:ASGLY)

OTC

Construction

842

Asahi Group

(OTCPK:ASBRF)

OTC

Beverage

3,561

Chiyoda

(OTCPK:CHYCY)

OTC

Industrials

822

Daikin

(OTCPK:DKILY)

OTC

Industrials

9,494

Fast Retailing

OTC

Retail

36,330

Fujitsu

(OTCPK:FJTSY)

OTC

Tech

533

Hitachi

(OTCPK:HTCMY)

OTC

Industrial

Engineering

490

Itochu

(OTCPK:ITOCY)

OTC

Support Services

1,275

Komatsu

(OTCPK:KMTUY)

OTC

Industrial

Engineering

2,311

Minebea

(OTCPK:MNBEY)

OTC

Electronics

1,003

Mitsubishi

Electric

(OTCPK:MIELY)

OTC

Industrial Engineering

1,305

Mitsui

(OTCPK:MITSY)

OTC

Support Services

1,395

Sumitomo

Electric

(OTCPK:SMTOY)

OTC

Electronics

1,503

Sumitomo Metal

(OTCPK:SMMYY)

OTC

Mining

1,350

Suzuki Motor

(OTCPK:SZKMY)

OTC

Transport

3,487

Taiheiyo Cement

(OTCPK:THYCY)

OTC

Construction

305

TDK

(OTCPK:TTDKY)

OTC

Electronics

7,150

Yamaha

(OTCPK:YAMCY)

OTC

Leisure goods

2,082

Exchange traded funds with broader Japanese sectoral exposure include iShares MSCI Japan (NYSEARCA:NYSEARCA:EWJ), Wisdom Tree Japan Hedged Equity (NYSEARCA:NYSEARCA:DXJ), and Deutsche X-Trackers MSCI Japan (NYSEARCA:NYSEARCA:DBJP). Closed-end funds include Japan Equity Fund (NYSE:NYSE:JEQ).

The takeaway here is trading anomalies and market distortions abound on Japanese exchanges as the BOJ continues to stimulate the economy by employing one of the widest arrays of policy initiatives the world has witnessed to date. Overall, government debt still ranks as one of the highest in the world. Bank lending in Japan has expanded for 58 months in a row through July, but overall economic growth cuts just short of stagnant. Household spending jumped 1.2% in February, which was the month after the BOJ introduced negative rates, but has fallen back in the past four months. Consumer spending remains weak, while corporate investment and earnings continue to suffer from the weight of a relentlessly strong yen. Achieving the BOJ's inflation target remains distant. Meanwhile, the BOJ purchasing regime has turned the overall yield curve flat, rendering bond yields roughly the same without regard to maturity. The literal nationalization of the Japanese financial system continues apace, and the tunnel is long, narrow and still quite dark.

This article was written by

Douglas Adams profile picture
1.58K Followers
Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in JEQ,TTDKY, ASGLY over 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.

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