To The Moon

In the first two months of 2024, the Japanese stock market continued to be strong, in which the Nikkei 225 index rose by more than 19% in the year ending March 5, while it rose by 28.2% in 2023.

The rally was fueled by ultra-loose monetary policy in the Japanese stock market, which was further fueled by the magnification of overseas profits of Japanese companies in the context of the depreciation of the yen.

In the short term, the Bank of Japan will not withdraw from QEE soon, and it will take time for the Federal Reserve to cut interest rates. Driven by the slowdown of economic growth and loose monetary policy, the depreciation trend of the yen will not be reversed, and the Japanese stock market bubble will continue to expand.

In the medium term, with Japan's inflation reaching the policy target of the Bank of Japan, the Bank of Japan withdrawing from suspending the yield curve control or ending QEE, there will be a greater downside risk in the Japanese stock market.

Liquidity is super loose, and the bull market of Japanese stocks expands

Looking back at history, Japan started the quantitative easing in 2001, and its scale continued to expand in 2016. In the first two months of 2024, the balance sheet of the Bank of Japan continued to expand, which means that the Bank of Japan is still releasing currency liquidity.

In the week ending February 29, 2024, the total assets of the Bank of Japan reached 760,400 tons, an increase of 2.8% over the same period of last year and a record high.

The picture shows the year-on-year growth rate of the average balance of Japan's base currency and the Nikkei 225 Index

Picture

We observed that the Nikkei 225 Index bottomed out in September 2008 and started a super bull market since November 2012.

Although there have been declines in July 2015 to June 2016, the first quarter of 2020 and 2022, the general trend is still upward and constantly hitting new highs, which has a lot to do with the continuous upgrading of Japanese quantitative easing.

The logic of the impact of ultra-loose liquidity on the Japanese stock market is as follows:

QEE will not necessarily drive economic growth, but it can prevent Japan's economy from falling into a deep recession.

Looking back at history, since March 2001, Japan has continuously upgraded its quantitative easing.

Except for 2008 when the financial crisis broke out, 2011 when the "European debt crisis" broke out and 2020 when COVID-19 pandemic broke out, Japan's GDP growth rate (annualized rate) rarely experienced two consecutive quarters of significant negative growth (recession), and the annualized rate decline of Japan's GDP in these periods was converging.

QEE does not necessarily drive inflation up, but it will boost asset prices with high probability.

For the stock market, evil inflation is the biggest enemy of the stock market rise. However, we find that since 2001, the Bank of Japan has implemented a quantitative easing and launched the Super quantitative easing (QEE) in 2013, and Japan's inflation has been at a low level for most of the time.

The depreciation of the Japanese yen ushered in double benefits in the Japanese stock market

First of all, as the subject of carry trade, the depreciation of yen will not trigger capital outflow, but also trigger a large amount of international capital flowing into the market and stock market overseas.

In 2023, the Japanese stock market rose sharply, which was largely due to international capital inflows, among which large international investment institutions represented by Buffett favored Japanese stocks.

From the perspective of Japanese financial accounts, the inflow of overseas funds into the securities market slowed down obviously in December last year, and the balance of securities investment in financial accounts dropped to 1.5 trillion yen, reaching its peak in September last year and once reaching 10 trillion yen. From the beginning of 2023 to mid-February 2024, the total net inflow of foreign capital exceeded US $55 billion, the fastest speed since 2014.

Second, the depreciation of the yen has magnified the profits of Japanese enterprises. Benefiting from the weak yen, the resilience of the US economy, inflation and other factors, the profits of large, medium and small enterprises in Japan are at a record high level. When the US dollar appreciates and the Japanese yen depreciates, the gains from US dollars against Japanese yen will benefit from the spread and increase extra.

Economic slowdown and inflation rebound have long-term risks

From the perspective of economic growth, Japan's economy has been slowing down since the second half of last year. According to common sense, the economic slowdown means that the profits of Japanese enterprises are declining, but the transmission of profits by this round of economic slowdown lags behind and has a small profit, which has an impact on the Japanese stock market in the second or third quarters.

The rebound in inflation may mean the end of super-easing by the Bank of Japan. On a month-on-month basis, Japan's CPI increased by 0.1% in January compared with December last year, after negative growth for two consecutive months in November and December last year, especially the Red Sea crisis, which has led to a sharp increase in the transportation costs of imported oil, natural gas and other energy in Japan.

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To sum up, before the Bank of Japan ends QEE, the loose liquidity of the yen and the depreciation of the yen will support Japanese stocks to maintain the upward trend, but due to the economic slowdown and inflation rebound, the upward trend will gradually slow down.

Inflation rebound may mean that the Bank of Japan may withdraw from QEE in the second quarter, and the potential downside risk is in the long term. Investors can use CME group Nikkei 225 Index futures contracts to capture short-term rising risks and hedge long-term falling risks.

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