CLSA: "The Bank Of Japan Has Nationalized The Japanese Stock Market"

Following the recent announcement by the BOJ that it would double its ETF purchases to ¥6 trillion, or $58 billion, up from the current ¥3.3 trillion, which is the equivalent to the Fed purchasing $580 billion in ETFs over the next two years, we noted that according to a Bloomberg analysis this would make the Bank of Japan the top shareholder of 55 companies by the end of 2017.

 

It should, therefore, come as no surprise that as CLSA's NIcholas Smith wrote in a research report, the "BOJ is nationalizing the stock market" because that is precisely what it is doing with every incremental intervention in the stock market.

Of note in Smith's note, first reported by CNBC, is that the BOJ's purchases are focused largely on funds tracking the Nikkei 225 index, estimating that more than half of the BOJ's ETF buying was likely in Nikkei-tied funds."That was particularly distorting because that gauge was "a Flintstones index from an abacus age," due to its arbitrary inclusions." He noted that Uniqlo owner Fast Retailing had the largest weighting in the index, but that was primarily due to its high share price after avoiding any stock splits since April 2002. He estimated that BOJ buying of Nikkei-tied ETFs worked out to more than 16 percent of the stock's free float each year. By comparison, Toyota Motor had the biggest market capitalization of any Japan stock, but was only ranked 15th by weight in the Nikkei index.

"If it seems strange that the BOJ is hamstringing the price discovery mechanism of the Japanese stock market by partially nationalizing it, it is all the stranger that it chooses to do so by substantially skewing its buying towards such a distorting index. The arbitrary decisions of the Nikkei committee get to choose the destination of trillions of yen of BOJ – and hence government - money."

Smith then laments an issue that has especially plagued bond buyers in Europe over the past few months: the CLSA analyst expects that as long as the BOJ continued to buy ETFs, the Japanese market's performance would become increasingly a function of liquidity in the central bank's buying basket. Considering that the BOJ will have to intervene far more aggressively in both the bond and stock market in the coming months to push the Yen weaker, liquidity is only set to get worse.

CLSA wasn't the only one to lament the nationalization of the Japanese market. In a Friday note, Deutsche Bank said that the BOJ's purchases of Japan real-estate investment trusts (J-REITs) had also lost market-based "price discovery."

Quoted by CNBC, they said that on August 18, the BOJ purchased around 1.2 billion yen worth of J-REITs for a total of around 61.2 billion yen worth so far this year and 330 billion yen worth since October of 2010. Last week's BOJ action caused the TSE REIT index to drop sharply in the morning session then surge later in the afternoon, the report said.  Because the J-REIT market is so small, the BOJ's purchases have an even stronger tendency to distort the market than the central bank's ETF purchases, Deutsche Bank said.

"While real estate majors are trading at more than 30 percent discounts to net asset value, their price levels are exactly opposite those of J-REITs, which are at premiums of above 30 percent," Deutsche Bank said, noting that both sectors should be tied to Japan's real-estate market.

"The elimination of the price discovery function leads to lost buying opportunities for investors and ultimately weakens the investment appetite," the report said, calling it a "serious error" by the BOJ.

Finally, Reuters summarizes these widespread fears of central bank incursion into the stock market, warning that the "Bank of Japan's near doubling of its purchases of Tokyo shares is causing investors to worry the central bank will dominate financial markets, which could lead to price distortions as it continues to grease the economy."

The BOJ's buying spree will make it harder for investors to sift good companies from bad, and raises a host of other problems including misallocating capital, making equities trading more speculative and reducing incentives for companies to meet shareholder needs, analysts say.

 

More than three years of massive monetary stimulus has already resulted in the central bank cornering the Japanese government bond (JGB) market and distorting interest rates.

"The increased BOJ purchasing provides a very favorable demand environment for listed equities," said Michael Kretschmer, chief investment officer at Pelargos Capital in the Hague. "Nevertheless, in the long run we strongly doubt these type of monetary gimmicks aimed at price setting of risk assets can have a sustained positive impact on economic growth."

In retrospect, what the BOJ is doing is not new: it is merely the latest act of desperation in a process that stretches over 30 years:

Some liken the increased purchases by the BOJ - the only central bank in the world that buys stocks at the moment - to failed government efforts over more than two decades to prop up the market by pressing government-related financial institutions to buy after the bursting of the late-1980s asset bubble.

Actually, one can add the SNB to the list of banks that are open about their stock purchases. As for central banks, such as the Fed which transacts in the equity market via a very "close" relationship between NY Fed and Citadel, they are for now ignored.

As for Japan, "the market is driven completely by the BOJ's buying rather than views on each companies' earnings," said a fund manager at a Japanese asset management firm.

This means that fundamental data and news are now completely ignored: all that matters - as has been the case for years in the US - is central bank intervention, either direct or indirect.

Some worry the stock market could start to resemble the bond market, where the BOJ's purchases - about 110-120 trillion yen annually - have made traders fixate on its bond buying and pay scant attention to economic data.

 

The BOJ's tactics "could weaken the market's function in the long run," said Keita Matsumoto, head of investor sales at Citigroup Global Markets Japan. "I'm worried that could lead to a 'JGB-ification' of stocks."

Yet what is obvious to all but the BOJ is that the good times will not last, and is why some are already casting glances at the exit signs: "The rise in share prices may seem desirable but it causes harm as well," said Shingo Ide, chief equity strategist at NLI Research Institute. "Even if companies need to improve their management, shareholders may not take them seriously if share prices are not falling."

The endgame, when it strikes, will hardly be a surprise: a quick historical lesson of what happens when the government nationalizes all capital markets, if one can even call them that, look at what happened with the USSR. For now, however, the money printers are spinning and "one has to dance."

Finally, one can probably absolve Kuroda of his sins - after all he is merely following orders of bankers from the private sector (recall that the BOJ launched NIPR following "peer pressure" at Davos) - by admitting that what the BOJ is doing is no different from the creeping capital markets nationalization that all other central banks around the globe have unleashed. Their redemption? They are doing it "for the people."

Comments

No comments yet! Be the first to add yours.