Japanese stocks have been disappointed thus far in 2014. On the one hand, some observers fear that Japan's policy makers are too complacent, given growing regional economic risks and the pending sales tax increases at home. On the other hand, just barely two years since the start of Japan’s bull market, it is perfectly normal to see that many investors still harbor doubts - just recall the various dangers the US and Europe seemed to be exposed to in 2011 and 2012.
Who will be proven right in the end? Those who believe in the successful reflation of an aging but formidable industrial economy, or those who view Japan’s 2012-2013 stock market surge as nothing more than the last hurray of a doomed has-been? In between these extremes, of course, we also have the opportunistic trend-followers - a faction that generally lacks strong convictions, but still plays the decisive role during transitory market phases. And that group has recently started to detach itself from its initial enthusiasm (if any) for “Abenomics”, to join the ranks of the doubters. Narratives about (supposedly) disappointing economic data serve to intellectually underpin this shift, which is occurring just before a much-feared consumption tax hike is due to take effect in Japan, and amid rekindled fears about the possibility of a major credit crunch in China, Japan’s biggest trade partner in Asia.
The economic arguments against Japan do not seem very convincing to us thus far. Needless to say, it is ultimately the market that is always right in the end - which is why it is useful to start with looking into the markets themselves for possible clues about the future. As always, we focus on medium-term trends and the bigger picture, rather than occasional, potentially confusing noise. To be sure, Japanese stock market performance has been disappointing since the beginning of the year. On closer inspection, however, the following observations appear particularly noteworthy in terms of qualifying that judgment.
The recent weakness of Japanese equities is not general, but primarily emerging against the US and Europe, while the market’s overall trading pattern still points to a normal “consolidation” after an extremely strong and sharp surge. After all, we must recall that from November 2012 to May 2013, in just six months, Japanese equities recovered about half of a huge performance gap that had been accumulated versus the rest of the world over the preceding four years. Following this extraordinary catch-up, however, Japan’s market pattern has started to duly “normalize” again - i.e. it is now more closely following the global pattern. This means that Japanese equities may no longer generally outperform as strongly and comprehensively as they did in 2012 and 2013, but it certainly doesn’t mean that Japan’s bull market trend has been broken.
Meanwhile, debt markets are not signaling noteworthy risks or problems either. Currently, there were two negative themes present in the markets: concerns about a possible escalation of the Ukraine crisis, and/or an even bigger economic slowdown in China. Such themes, generally tend to support the so-called “risk-free” sovereign bond markets. That said, any deviation from such a general (and temporary) uptick in risk aversion, such as a big deterioration in the underlying views on Japan’s outlook, for example, should sooner or later manifest itself in the broader debt markets in some way.
However, there has been no abnormal shift within the debt markets either: Japan continues to perform in line or better than Germany, the best-rated sovereign borrower among the major economies. In addition, the euro periphery’s bonds also continue to perform even better, which is in line with preexisting trends as well, and hardly a sign of a deteriorating global risk appetite. Concluding, what is true for all markets is also true for Japan. Despite some worrying headlines, none of the established trends have actually really changed in recent weeks or months. Japan’s stock market consolidation may be taking a little longer than we would have expected three months ago, but it is still most probably just that - a transitory pause, rather than the end of the bull market.
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Note: The next LGT Beacon will be published on 2 April 2014.