While the wholesale disappearance of retail traders from stock markets is hardly a novel observation, it has taken on a whole new meaning in Japan, where the lack of carbon-based investors has prompted Deutsche Bank to ask if "Japan's stocks are still traded at all by humans."
As Deutsche strategist Masao Muraki writes, since the US presidential election, Japanese stocks (in this case the TOPIX index) have been almost entirely defined by just three things: US stocks (S&P 500), the implied volatility (VIX), and USDJPY. This is shown in the model correlation chart below.
And while some observers think that foreigners are buying Japanese stocks on hopes for Abenomics following the Lower House election, this aspect is not apparent in the Figure above according to Deutsche. Instead, according to the German bank, it is the 10Yr US yields that determine relative performance of Japanese and US financial stocks most directly. Additionally, interest rates, forex, and option prices (implied volatility) are defining absolute share prices for Japanese life insurers and banks, as shown in the charts below.
Furthermore, while financial institutions delivered some surprises in earnings announcements and shareholder returns and major developments took place in bank and insurers capital regulations in 2017 too, Deutsche notes that it "cannot find any indications of active change in allocations to life insurers and banks by investors due to these factors."
These observations prompt Deutsche to ask "a basic question", namely "whether the power of price decisions for Japanese stocks (particularly financial stocks) have shifted from people to algorithms or AI." Some additional thoughts:
Shift to passive fund management has accelerated, partially due to the impact of the Department of Labor’s fiduciary rules, and the trading share of active funds, which follow decisions led by human, is declining. With reduced influence, active funds appear to be focusing on sectors with drastic fundamentals changes (such as technology sector). In fact, more than 70% of inquiries from overseas equity investors to our insurance, securities, and other financial sectors team in December were about SBI, which indirectly owns cryptcurrencies. Reduction of active management costs due to MiFID2 might accelerate this activity.
And since Deutsche is clearly correct that increasingly more, if not the vast majority, of trading decisions and execution has shifted from humans to machines, the outcome is concerning, because as the German bank notes, "if the price formation based on model is prolonged, the gap between price and fundamentals will be wider. Thus, stock price correction may occur periodically."
Yet while Japanese equities may no longer be interesting to local humans, the same can not be said for bitcoin, where as the same DB strategist "discovered" two weeks ago, it was mostly "Mr. Watanabe" trading the world's most popular cryptocurrency:
An 11 December Nikkei report stated that 40% of cryptocurrency trading in Oct-Nov was yen-denominated. Japanese traders have reportedly come to account for nearly half of cryptocurrency trading since China started to shut down cryptocurrency exchanges, and this is said to be widely known among industry insiders (various estimates exist). This report shows that Japanese men in their 30s and 40s who are engaged in leveraged FX trading (or who used to trade but have stopped) are driving the cryptocurrency market.
This in turn prompted us to wonder, tongue-in-cheek, if Bitcoin wasn't a secretive ploy by the BOJ - which has had a far more permissive approach to bitcoin cryptocurrencies than its central bank peers - to boost Japanese animal spirits, which had been squashed by three decades of chronic deflation and disenchantment with rigged equities. Today, Deutsche Bank poses a similar question when it asks "Will Bitcoin ignite the “speculative spirit” of Japanese people?"
We will be closely monitoring the risk-taking stance of Japanese retail investors in 2018 in light of the management of ¥900trn of the ¥1,800trn as deposits in overall personal financial assets. Japanese retail investors eagerly purchased certain assets at prices with little support from fundamentals during the bubble period in the 1980s and the IT bubble period around 2000. Symbolic choices were NTT shares that listed in February 1987 for the former and Hikari Tsushin shares that listed in 1999 for the latter (Figure 1).
The emergence of “Bitcoin wealthy” might ignite the “speculative spirit” of Japanese people with strong follower aspirations.
Taken to its extreme, encouraging speculation in bitcoin - and in general any asset that is up over 15x YTD - would be a perfect way to rekindle not only animal spirits, but Japan's reflationary impetus. One can see why the BOJ could, if not would, be behind such a "wealth creation" mechanism.
Finally, as Deutsche accurately points out, "of course, speculation at prices with flimsy fundamentals support unleashes strong backlash once asset prices weaken. Overly leveraged trades, in particular, are a concern. Cryptocurrency prices plunged on 22 December, and we think this impacted retail investors using margin trades."
Well, not really, because the December 22 plunge is now long forgotten, and the real question one should ask is whether the Bank of Japan had anything to do with the sharp rebound in bitcoin which plunged as low as $10,500 last week before surging back to $16,000 earlier today...