On Tuesday, Japanese stocks took the worst drubbing of the major Asian stock markets. The Nikkei plunged 725 points or 3.84% to 18,165. On August 10, it had set a multi-year high of 20,808. At the time, Japanese stocks gleamed; they’d elegantly skirted the China swoon. But over the past three weeks, the Nikkei has dropped 12.7%.
Japan has some, let’s say, issues. Private consumption dropped 0.8% in the last quarter, and GDP dropped 0.4%. The economy shrank in six of the past 12 quarters. That’s how well Abenomics has worked out for the economy.
But during that time, stocks have more than doubled! That’s where the real impact of Abenomics has been.
To his credit, Shinzo Abe decided to achieve a national consensus on how to deal with Japan’s mountain of government debt and mega-deficits that add to it every year. He ran on that platform in 2012: Japan would print itself out of its fiscal troubles. And the price would be paid over time by the Japanese people.
The Bank of Japan had been engaging in QE before the term had even been invented, buying Japanese Government Bonds (JGBs) and equity ETFs as part of its policy. But under Abenomics, its purchases skyrocketed, purposefully strangling the JGB market, thus taking complete control over it.
If it loses control, the world will see the most epic debt crisis ever. Since nearly all JGBs are held in Japan, a debt crisis would spread chaos over the land. So there won’t be a debt crisis. That’s the message. There will be other crises, but no debt crisis.
With its mega-QQE program, the BOJ has purposefully watered down the yen, thus firing off an explosive round in the currency war a couple of years ago, hitting South Korea and China directly.
And it has inflated the prices of stocks and real estate, not only indirectly as the Fed has pioneered on a massive scale, but also directly, by jumping with both feet into equity ETFs and Japanese Real Estate Investment Trusts (J-REITs).
By the end of 2012, just before Abenomics became effective, the BOJ carried on its balance sheet ¥1.5 trillion in equity ETFs and ¥111 billion J-REITs. As of its August report, its holdings of ETFs have soared to ¥5.9 trillion and J-REITs to ¥245 billion. It now holds about 2.3% of all J-REITs by market capitalization!
To further inflate asset prices, the government also converted the reluctant, conservatively managed, low-cost, thinly staffed Government Pension Investment Fund (GPIF) into a hedge fund. It would dump a big chunk of its JGBs into the lap of the BOJ and buy riskier domestic and international assets, including “alternative assets.”
When these discussions surfaced, Japanese stocks soared. The whole world was watching. As more details trickled out, Japanese stocks soared. When the fund announced that it would raise its holdings of Japanese stocks to 25% of its total assets, stocks soared. Everyone knew that the fund, with ¥141 trillion in assets ($1.17 trillion), would be an enormous force in the markets: it would buy ¥35 trillion in Japanese stocks in a short time.
When the GPIF started buying, supported by the BOJ’s ongoing ETF purchases, stocks soared. The entire world of hedge funds was riding this gravy train to financial nirvana.
Other Japanese pension funds followed the same model. They would fill their increasingly large funding holes by loading up on riskier assets, particularly Japanese stocks that could only go up.
So the hype about Japanese assets has been enormous. Foreign hedge funds piled into stocks and J-REITs. The Chinese piled into Tokyo prime real estate. The wealth effect from asset price inflation would make a few folks large amounts of money.
J-REITs were hot. Back in mid-January, the Tokyo Stock Exchange J-REIT Index hit 2,000. It had doubled over the Abenomics years. It had become the manifestation of the power of the BOJ and the government to manipulate up the stock market in a targeted and precise manner.
But last week, the GPIF released its statement for the quarter ended June 30. Turns out, the fund nearly completed its shift into Japanese equities, having increased its holdings of them to 23.4% of its total assets, just 1.6 percentage points short of its target of 25%. By now, that target has likely been reached. And the GPIF has stopped buying Japanese stocks.
The whole world of hedge funds knows that. Now the Nikkei is down nearly 13% in three weeks, and in the general swoon of Japanese stocks, J-REITs got eviscerated. Today, the J-REIT Index closed at 1,621, down 19% from January.
Investors that had hopped on that gravy train are now re-learning a lesson. Central banks can control their government bond markets. They cannot control their stock markets. They can only manipulate them. But that manipulation works only if everyone believes in it.
Japanese consumers have borne the brunt of Abenomics, and they’re now hitting the real economy. Read… Worst Year for Car Sales in Japan since Earthquake Year 2011