The impact of the US presidential election on the market (Part 2)

The issue of Japan's "distorted" stock market

The selling of Japanese stocks by foreign investors just won't stop. According to a publication by Japan Exchange Group, the amount of Japanese stocks sold by foreign investors between January and the third week of September 2016 reached 6 trillion yen.

During the three months between January and March, a fierce trend of selling continued, with sales reaching roughly 5 trillion yen. During that time, the Nikkei Stock Average fell from its 18,951 Yen high at the first session of the year on January fourth by 21.5% to 14,865 yen on the twelfth of February. The plunges in the crude oil market, or the sharp appreciation of the yen due to the postponement of the US rate hike were the main causes.

Following this, there was a seesaw like situation, with foreign investors buying 860.4 billion yen worth in April, but the start of September yet again saw a huge amount of selling. This also was almost certainly due to predictions of the US FRB's rate hike slipping to the end of the year at earliest strengthening the pressure on the high yen.

Some individual investors are modestly hopeful, thinking "if it's gone over 6 trillion, won't it flip over to buying soon?", but this really is nothing more than hopeful thinking. This is because foreign investors bought around 24 trillion yen of Japanese stocks between 2010 and 2014 (with 325.7 billion yen being sold in 2015). In order for foreign investors to switch to buying, what is most likely needed is for the trend to switch towards a low yen.

In the first and second sections of the Tokyo Stock Exchange listings, many corporations set their expected March 2013 period exchange rate at 110 yen (with major car manufacturers at 105 yen). While the dollar yen rate is shifting to $1=\100, it is hard to imagine foreign investors aggressively buying Japanese stock due to increasing concerns about downward revisions leading up to the end of the fiscal year.

However, in spite of this widespread selling by foreign investors, who are major players in the Japanese market, the Nikkei Stock Average drop since the start of the year has remained small with percentages in the 10 to 20% range.

There is a trick to this. ETF (Exchange Traded Funds) buying by The Bank of Japan. The BOJ, as part of monetary easing measures, implement ETF buying at such times as big stock price drops. From January to the end of September, they bought approximately 3 trillion yen of ETF (See: "The result of ETF Purchasing" - BOJ announcement). In short, the BOJ absorbed half of the foreign investor selling.

Currently, the framework for ETF buying by the BOJ is set at 6 trillion yen. According to estimates by the Nikkei, by the end of August 2016 one quarter of the companies listed in the first section of the Tokyo Stock Exchange will be substantially owned by the BOJ. Further, if this buying were to continue as is, Nikkei also calculated that by the end of 2017 out of the 225 flagship stocks in the Nikkei, the BOJ would be the largest shareholder of 55 of them. While the name on the stock roster wouldn't directly be that of the BOJ due to buying them through ETF, a situation where the central bank and the largest stockholder for flagship companies is clearly a "distorted" one.

The problem is, this support for buying by the BOJ cannot continue forever. Naturally, even the balance sheet of the BOJ has a limit. It is inevitable that a period of decreased purchasing by the BOJ will come around as an "exit" from this historical financial easing. While this may not be for a while, within a few years or more, as long as the Japanese economy does not undergo major change, this is likely to be a major ordeal for the companies that have a large amount of stock held by the BOJ.

Incidentally, the BOJ also has also bought REIT (Real Estate investment Trusts), at a smaller scale of 90 billion yen annually. More and more voices are pointing out the limit of "quantitative" monetary easing in the market, and increasing the buying of national bonds or stocks may be difficult. However, the BOJ, which aims for an inflation rate of 2%, is left with the possibility of increasing REIT purchasing anticipating an asset effect.