Since Japan's current Prime Minister Shinzo Abe won his office on September 26, 2012, Japan's Nikkei has skyrocketed 113% under the expectations, which were indeed fulfilled, of easy monetary policy now known as Abenomics. Unfortunately, despite that meteoric rise, the Nikkei is still almost exactly where it was in June 2007.
Even sadder, it's still over 100% off its highs put in way back in 1989. And here's the kicker: while the Nikkei was busy chugging 113% higher in Yen terms, the Yen itself was busy collapsing 36% against the U.S. dollar, as well as most other major currencies, in the same time frame.
Since the advent of Abenomics, the Bank of Japan without question has engaged in the largest bond-buying quantitative easing experiment in world history. But not only Japanese government bonds (JGBs) have been bought during this massive Japanese quantitative easing. During its last round of QE announced in October, the BOJ stepped up purchases of ETFs and REITs as well, increasing its direct presence in the Japanese stock market to unprecedented levels.
And yet, despite this record breaking asset-purchase money-printing bonanza, the actual yen supply in circulation is having trouble moving up. The latest numbers from the BOJ published March 10 are ¥891.2T in the M2 money supply consisting of circulating cash, demand deposits, and short maturity time deposits. When we get to numbers bordering on quadrillion, they certainly seem big, but the rate of increase is what matters. The total is actually down from January's ¥895.4T.
A one month blip down is no big deal and happens all the time, but if we take a wider look we see something more ominous. Going back to November 2014 right after the last QE was announced, Japan's M2 was at ¥885.8T. From then to now, the circulating Yen supply has only gone up 0.6%. That is not enough to sustain the massive 30% growth in the Nikkei over the same time period. So where is this growth coming from if not from the extra Yen in circulation? The answer must be the BOJ's direct purchases of ETFs and REITs since November. The Yen used to purchase these securities is being locked up in excess reserves somewhere in the Japanese banking system, instead of entering the economy through loans. The result is higher asset prices with a static money supply.
It's one thing for a central bank like the BOJ to manipulate the capital markets indirectly by creating money to buy bonds and push down interest rates. It's another thing entirely to manipulate the capital markets directly by creating money to purchase securities outright and jacking the bid higher. The latter is much more dangerous.
As long as it keeps on going, of course, the Nikkei will continue to chug higher. That's what happens when you create money and put it directly into the stock market. But the BOJ has recently signaled that it will stop its open market purchases of Japanese securities. On March 9, Deputy BOJ Governor Hiroshi Nakaso said in a speech to business leaders in Matsuyama, Ehime Prefecture, "If falling oil prices lower inflation but inflation expectations remain unaffected and inflation keeps heading toward 2% as a trend, there will be no need to respond through monetary policy."
In other words, it seems that the BOJ is entirely focused on the consumer price index and not the Nikkei. The CPI will determine whether outright open market purchases continue or not. And right now, the CPI is and has been stable since November.
The next Japanese CPI numbers come out on March 26. If they stay stable or trend higher, we can expect the BOJ to stop, or at least slow down, its outright ETF and REIT purchases on the Japanese stock market. Supporting an end to the current round of Japanese QE is the fast-falling Yen that cannot seem to recover against any currency, let alone the skyrocketing U.S. Dollar.
The consequences of the BOJ ending direct asset purchases on the Japanese stock market would most likely be a collapsing Japanese stock market, as BOJ securities purchases seem to be the only reason that the Nikkei has been doing so well lately. Had Japan's money supply actually been expanding during this time, then one could argue that the rally is more broad-based and coming from multiple directions from more money in the banking system. But the Yen supply has been static since the BOJ's latest round of QE began.
What now? Look for a top in the Nikkei sometime soon, especially if Japan's official CPI inflation rate comes in stable or higher. That should signal at least a temporary end of direct BOJ intervention.
2 ETFs to Short to Take Advantage of Japanese Stock Market Downturn
In order to take advantage of a turn south, there are two main options in terms of ETFs one can short, either directly or through options. The first is the iShares MSCI Japan ETF (EWJ) - Get Report , which has greatly underperformed the Nikkei by 17% over the last year. This could mean it will also lose value faster than the Nikkei itself if and when the BOJ announces a less accommodative monetary policy. The second is the WisdomTree Japan Hedged Equity ETF (DXJ) - Get Report , which has the added benefit of underperforming when the Yen rises relative to the dollar.
If the BOJ confirms no more QE, which it has already hinted at, then the Yen is likely to rise relative to the dollar, pushing DXJ down even faster than EWJ, which is not hedged against the Yen.
This article is commentary by an independent contributor. At the time of publication, the author was short DXJ.