Japan's market had been soaring until it tripped this week for no good reason. Expect more of this in 2013, as investors flit from market to market in search of reliable returns, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
On January 16, Japan's Nikkei-225 index fell by 2.6%. That was doubly surprising.
First, it was surprising because the Tokyo stock market has been on such a roll-up 25.6% from November 14 to January 15, and 9.4% from December 21 to January 15.
And second, because the "cause" of the drop was a series of absolutely innocuous remarks by a member of the Japanese parliament (who pointed out that a weaker yen wasn't great for Japanese consumers) and two members of Prime Minister Shinzo Abe's cabinet (who noted that a weaker yen wasn't good for all Japanese companies).
That was enough to send Japanese stocks down 2.6% on the day?
Welcome to the wonderful world of hot money, 2013-style. So far this year, we're looking at a market that doesn't have any confidence that the trend of this moment will be the trend of the next moment. And the market is, therefore, constantly sloshing toward the opportunity of the minute or away from the possibility that a trend has peaked.
I think these sloshes will make emerging markets-with their smaller market capitalizations than those of the United States, Europe, or Japan-especially volatile. And that, since these are the markets that look poised to do best in 2013, makes for some very tricky footing for investors.
Let's take a slightly more detailed look at what happened in Japan, and then see how these dynamics apply to the rest of the global stock market.
Finding the Good in Japan
The rally in Japan is all about the yen. There really isn't anything else to get very excited about.
The Japanese economy is in recession, and the World Bank forecasts that its gross domestic product will grow by 0.8% in 2013 and 1.2% in 2014. The economy operates well below capacity, with the output gap (the difference between the economy's full capacity and the rate at which it runs now) at 5% to 7%.
The debt-to-GDP ratio is 240%, the highest in the developed world, and with tax revenue at a 24-year low, the government takes in just 100 yen for every 200 yen it spends. The population is aging-23% are expected to be older than 65 in 20 years, up from 12% now-and shrinking, with the population forecast to fall to 90 million in 2050 from 128 million now.
One bit of black humor making the rounds of demographers in Japan: On current trend, in 600 years there will be 450 Japanese left. And those Japanese will be markedly poorer.
Japan's 5% unemployment rate is low by international standards, but high compared against the country's pre-1991 unemployment rate of 2% to 3%. Average annual salaries have declined every year since 1999, and are now down 12% in all. About 34% of the labor force now works in part-time or contract jobs, up from 20% in 1990. In 2009, according to government statistics, 15.7% of Japanese-including 14% of children and 21% of the elderly-lived below the poverty line.
Clearly, you don't put money into Japan to profit from the medium- or long-term trends. (That there will be a long term is due solely to the extraordinary frugality of past generations of Japanese savers; the country is still sitting on $19 trillion in savings.)
You do, however, put money into Japanese stocks-especially those of Japanese exporters-in the short run because of the decline in the yen and projections of a continued decline. The yen has dropped by 14% against the US dollar since October.
Not exactly a small thing when Toyota Motor (TM) figures that every 1 yen swing against the US dollar produces a $397 million swing in annual profit for the company. At Nissan Motor (NSANY), the shift from a recent 89.21 yen to the dollar and the 2012 average of 79.82 yen to the dollar is worth a 34% increase in profit.
No wonder shares of auto exporter Mazda Motor (MZDAY) are up 114% from October 30 to January 16. And no wonder global cash has started to chase hitherto scorned Japanese equities. Cash flow into Japanese-domiciled investment trusts turned positive in October for the first time in two months.
But How Low Can Yen Go?
The problem, though, is that almost everyone putting money into Japan is doing so while asking, "When does this end?"
The yen, which closed at 88.31 to the US dollar on January 16, could easily go to 90, or with more difficulty to 95 or even 100. But the trend won't last forever.
There are major forces pushing back against the campaign of Abe's government to weaken the yen. Every decline in the value of the yen against the dollar increases Japan's bill for dollar-denominated oil and natural gas. Every drop in the yen takes another bite out of already stressed Japanese workers and consumers.
Whatever the willingness of the Abe government to pile debt on top of debt to weaken the yen and revive Japanese growth, its capacity to do so has limits. And it's the knowledge of those limits that gave relatively gentle comments about the costs of a weak yen the power to move stock prices in Tokyo.
And, of course, because the money that flowed into Japanese stocks in order to take advantage of a falling yen really has no belief in Japanese stocks or the Japanese economy in even the medium term, it has no loyalty to Japanese markets. Given the slightest signs that the short-term party is over, this money starts to look for a hot time in some other market.
Think the decline of the yen-and hence the rise in Japanese stocks-might be coming to an end in the next few days or weeks? Well then, how about the current China rally? Is it time for global money to slosh into Hong Kong and Shanghai?