Contrary Views On the Japanese Market

Yesterday's post asked the question:  Is is time to buy Japanese stocks? 

The tone of my piece was skewed towards the bullish side, as I am always intrigued by areas that seem out-of-consensus.

But I must confess, as I studied the idea more yesterday, I am now starting to feel like maybe more patience is called for before buying stocks in the Nikkei.

For example, chief investment strategist Tim Hayes of Ned Davis Research Group ranks Japan near the bottom of the world's equity markets in terms of attractiveness, and would strongly underweight Japan in any global portfolio allocation.  Here's what he recently wrote:

As for the Japanese market, the equity performance has yet to indicate a meaningful change in economic expectations, valuations are unattractive, and investors remain discouraged by weak earnings growth and profit margins.  Entering 2013 we are maintaining our strong underweight allocation to Japan, while continuing to overweight emerging markets and Pacific ex. Japan, a region that's also relatively attractive on a valuation basis.

Then there's this article that appeared on the CNBC website.  The piece cites a number of Japanese analysts that note that the Nikkei has rallied in anticipation of new Prime Minister Abe's proposed expansionary fiscal and monetary policies.

However, it is not yet clear that the actual implementation of the policies will prove successful:

Geoff Lewis, global market strategist at JPMorgan Asset Management in Hong Kong agrees on the need for caution, saying the firm has a neutral position on Japanese shares.

"Japanese shares have rallied quite a lot, with markets anticipating a big change in policy, but a lot now rides on implementation.Short-term, this is not a rally you really want to chase," he said.

"It's pretty hard to predict what the outcome will be. The first Abe regime was pretty disappointing and did not achieve much and if you look at the amount of stimulus that the Japanese economy might hope to get from a 10-15 percent fall in the yen, it's not that much," Lewis said referring to expectations for a weak yen to boost economic growth between 0.25 percent and 0.5 percent in the fiscal year starting April 1.

http://www.cnbc.com/id/100368430

Finally, here's David Keohane of FT Alphaville echoing the same themes as the CNBC article; namely, the track record of PM Abe during his first term in office was something less than stellar, and it is not clear that this time will be any different.

Keohane quotes extensively from a report published by Standard & Poor's but here is an excerpt (I added the emphasis):

The biggest cause for skepticism is simply the scale of the policy moves that would likely be required. The BOJ should be able to use monetary policy to bring an early end to deflation. But the BOJ failed to do so in the past and therefore has a serious credibility deficit when it comes to fighting deflation. And having gone on for so long, deflation expectations have become “hard-wired” into the economy and in the mindsets of economic agents. So the scale of the policy action (QE) required to change the equilibrium behavior of the economy and dislodge deflation expectations would likely be dramatic and literally “off the charts.” For a society and political culture that favors consensus and incrementalism, and for an institution as inherently conservative as the BOJ (at the best of times central banks tend to be conservative institutions), the required actions may just not fall within the set of practically feasible options.

http://ftalphaville.ft.com/2013/01/08/1326903/moving-targets-and-a-lack-of-self-belief-at-the-boj/ 

 So perhaps caution is warranted at this time.

Is Now the Time to Buy Japanese Stocks?

The Japanese stock market would seem to be a terrific opportunity.

The valuation of Japanese stocks is among the lowest among the developed markets.  At a price/book ratio of 1.1x, the Nikkei is trading at half the valuation of the U.S. market.

At the same time, consensus earnings growth estimates for 2013 are the highest among the same group of developed markets.  IBES EPS growth estimates for the stocks in the Japanese stock market are +18.6%, or more than double IBES estimates for U.S. stocks.

Led by new Prime Minister Abe, the Japanese government attempting to their own form of "quantitative easing" by instituting huge increases in government spending.  Abe is also aggressive pushing the Bank of Japan to even further open the monetary floodgates to pull the economy out of the deflationary gloom in which it has been mired for decades.

If successful, the Japanese government actions will doubtlessly weaken the yen, helping Japanese companies that have suffered in recent years with the relentless strengthening of the yen.

Finally, Japanese stocks are the most unloved group among global investors.  According to Merrill Lynch, a recent survey of fund managers indicates that holdings of Japanese stocks stands at 3.5 year lows. Merrill notes that Japan is just 7% of the global equity market, compared to 44% in 1988.

Here's what famed global investor Felix Zulauf said in a recent Barron's interview (as reported on Fusion Blog):

Fusion: How does Japan look right now? We note you called for shorting the Yen at a Barron’s conference in October – again, a very prescient call.
Zulauf: Japan’s economy is not doing well and still suffers from deflation. The pronounced deterioration of Japan’s current account and the disappearing ability to finance her own large budget deficits are forcing some important changes. The new government in Japan, led by the LDP and Prime Minister Abe, has a 2/3 majority in parliament and can push through their own will without any problem. Abe wants some increased deficit spending, on top of a budget deficit that is already near 10% of GDP. He wants the Bank of Japan to finance a big part of it by printing new money and thereby weakening the Yen and targeting 2% inflation. If the BOJ doesn’t comply, they have basically been told they will lose their independence as a central bank.  The spending will increase deficits further and weaken the currency, which should improve exports.  I see Dollar/Yen going to 120 within the next 2 years, and the Yen weakening decidedly against all major currencies.


Fusion: So you’re clearly still constructive on China and Japan …
Zulauf: China’s market rebound should at least last during the first half of this year. There is still another 20% to go. After a consolidation and pullback, you can buy FXI here to play it. As for Japan, I am much more bullish as nobody owns Japanese stocks. The total market cap of the market there is one quarter of what is was 23 years ago. If the currency continues to decline against all the others, there will be a tremendous lift to Japanese equities. The Nikkei has at least another 20% upside in 2013 and could do more and last longer, all in local currency terms.

http://www.fusionmarketsite.com/?p=2212&buffer_share=14d28

So there you have it:  cheap markets; unloved stocks; and identifiable catalysts in the year ahead.

And yet:

Global managers have attempted to play a rebound in Japanese stocks for years. While there have been several periods of strong rallies, Japan has disappointed for years.  The Nikkei today stands at 10,578; in 1989, the Nikkei topped 39,000.

But is this time different?

Could Japan Provide The Next Catalyst for Global Equities?

Japan overwhelmingly elected Shinzo Abe to be their new prime minister last weekend.

Japan PM Abe (courtesy NY Times)

This will make the second time as Japan's PM for Abe.  His first foray lasted just two years, and was not considered a success by most.  He resigned for health reasons in 2007, but now apparently has healed sufficiently to be able to regain the top post.

In the campaign, Abe vowed to put maximum pressure on the Bank of Japan (BOJ) to loosen the monetary reigns to try to revive Japan's moribund economy.

Like the Fed, the BOJ is supposed to be free from political pressures, and act in a manner that is consistent with maintaining a sound banking system.  Now, Prime Minister Abe is about to turn up the political heat in a big way.

Japan is in a deflationary funk. Abe wants the Bank to target a 2% inflation target by printing vast sums of money.  In addition, Abe will once again increase spending on public infrastructure to try to restart the domestic economy.

Many Japanese observers are skeptical that Abe's plans will work. They note that most of his prescriptions have been in place for years, with only modest effect.

Still, the Japanese electorate was sufficiently fed up with its stagnant economy that it was willing to return to power a man who only years ago left in disrepute.

Ambrose Evans-Pritchard, one of my favorite columnists who writes for the London Telegraph, thinks that Japan's attempts to rekindle economic growth will be important for the global economy.  He compares Japan's plans to the aggressive quantitative easing efforts done by Switzerland and the United States.

If successful, the Japanese yen will weaken, allowing its manufacturers to become more competitive. At the same time, ultraloose monetary policy targeting higher inflation rates could cause the yields on Japanese Government Bonds (JGBs) to rise significantly for the first time in decades.  Higher interest rates could have a disastrous effect on its government deficits.

Here's what he wrote yesterday:

Mr Abe plans to empower an economic council to "spearhead" a shift in fiscal and monetary strategy, eviscerating the central bank’s independence. 

The council is to set a 3pc growth target for nominal GDP, embracing a theory pushed by a small band of "market monetarists" around the world. "This is a big deal. There has been no nominal GDP growth in Japan for 15 years," said {Japan analyst Lars} Christensen... 

The {Abe's party}LDP plans what some have dubbed a "currency warfare fund" to weaken the yen with a blitz of foreign bond purchases, copying Switzerland’s success in capping the franc. 

The effect of Switzerland’s unlimited bond purchases has been to finance most of the eurozone’s budget deficits for the last year with printed money. If Japan tries to do this - with a vastly bigger economy - it would amount a blast of quantitative easing for the world. 

http://www.telegraph.co.uk/finance/economics/9751609/Japans-Shinzo-Abe-prepares-to-print-money-for-the-whole-world.html

Quantitative easing in the country has provided one of the main sparks to the rise in stocks that has occurred since 2009.  If Japan - still one of the largest economies in the world - adopts a similar policy stance, this could provide a major spark to equity markets around the world.

Welcome to Japan

Years ago, when bond yields were still at levels that made investment sense, economists and politician assured us that global interest rates would never reach the ultra-low levels seen in Japan.

So much for that.

One starts running out of adjectives to describe just how low interest rates globally have gotten. Here's one description, courtesy of Merrill Lynch's Chief Global equity strategist Michael Hartnett:

“Japanification” of rates almost complete; average US/UK/German bond yield
has rallied from 5% to 1% since 2007; 17 countries now have 2-year bond yields below 1%; 10 countries (with combined bond market cap of $27 trillion) have yields out to 2-years on curve at 0%; average yield on 6-month bill auctions in Germany -0.034% and in France -0.006%, i.e. negative.

Moody’s AAA corp bond currently yielding 3.6%, lowest since June 1958;

Moody’s BAA corp bond currently yielding 5.0%, lowest since Nov 1965.

http://rcr.ml.com/Archive/11183495.pdf?w=dglen%40bpbtc.com&q=fN9V0PQa8G3pElDa7-dZhQ&__gda__=1342183164_c29d667aace0d1a3ab991c7080ba579d

Earlier this week, the U.S. Treasury sold 10 year Treasury notes at an all-time record low yield:  1.459%.  Demand was robust,  apparently lead by the Chinese government.  Today's yields are more than 20 basis points lower than the levels seen at the height of the financial crisis in the spring of 2009.

Writing in this morning's Financial Times, Gillian Tett reports that corporate cash levels continue to move higher, despite in many cases negative interest rates.  The mood of uncertainty and fear permeates the business world, just as it does the investing public:

That is partly because many American companies are profitable. But it is also because companies are holding onto this money, rather than spending it on productive investments or giving it to shareholders, so fearful are they about the future. Cash has thus become like a corporate security blanket, something executives cling to in frightening times.

In some senses, all of this is already well known. But what is less widely appreciated is that companies are not just refusing to use their money to invest in tangible ventures – they are running scared from the capital markets too. In 2006, the AFP says, corporate treasuries placed a mere 23 per cent of their funds in banks. But last year, the proportion of funds sitting in banks doubled – and this year it rose above 50 per cent.

http://www.ft.com/intl/cms/s/0/e234e886-cc38-11e1-9c96-00144feabdc0.html#axzz20R0JwEHI

Interesting, all of this is occurring at a time when some economists are seeing possible signs of a economic pick-up in the second half of 2012, as the New York Times reported this morning:

Despite the recent run of disappointing economic data, a broad range of experts and forecasters expect the economy to improve slightly in coming months, thanks to lower oil prices and new signs of life from sectors like automobiles and housing....

 

This week, Macroeconomic Advisers, an economic consultancy often cited by policy makers, estimated the annual rate of growth in the second quarter at just 1.2 percent — well below the pace needed to reduce the unemployment rate. But the firm also projected growth to accelerate to around 2.4 percent in the third quarter.

“The pace of economic growth is picking up, but not to a rate that is very robust,” said Joel Prakken, the chairman of Macroeconomic Advisers. “It certainly is no great shakes.” 

http://www.nytimes.com/2012/07/13/business/economy/in-latest-data-economists-see-signs-of-pickup.html?hp 

Welcome to Japan, I guess.

Is the Japanese Economy Really As Bad as Portrayed?

In the late 1980's, I started traveling to Japan a couple of times a year.

Japan was the envy of the world at that time.  Books were published in the US describing how the Japanese "miracle" had turned a country ravaged by World War II into the most vibrant economy in the world. Land values soared in Japan, and at one point it was estimated that the land under the Imperial Palace (3 miles in circumference) was worth more the entire state of Colorado. The Nikkei hit 39,000 in 1989, and few observers dared to suggest that Japanese stocks were overvalued.

My work in Japan was mostly with the banking area.  Using Fannie Mae mortgage-backed securities, I had developed and managed a series of mutual funds targeted for Japanese banks and insurance companies.  The funds were mostly successful - the demands for alternative asset classes in the Japanese financial sector were high - so I had the chance to meet with Japanese executives on a regular basis.

The timing of my work in Japan - which extended from 1989 to 1997 - gave me a front row seat at the unraveling of the Japanese miracle.  As it turned, my initial trips to Japan also coincided with the peak of Japanese economy.  In retrospect, the entire Japanese financial system was in the midst of a giant bubble, which started to deflate in 1990.  Since so much of the system was based on leverage, the more prices fell, the more the decline accelerated, as panicked borrowers sold assets to meet repayment demands.  The largest Japanese banks - which had been so eager to fuel land and stock speculation - turned into "too big to fail" zombies in just a few years, kept alive by the government.

Japan is often cited as a cautionary tale in this country. There are numerous unfortunate similarities: high debt levels, rampant financial speculation, and huge money center banks weighed down by the legacy of bad lending.  Indeed, Fed Chairman Bernanke was critical of Japanese authorities for not being more aggressive in addressing their problems in the 1990's, which in part explains some the Fed's moves in the past few years.

However, in recent months there have been several commentators that have been suggesting that, hey, maybe living in Japan these days really isn't so bad after all - the stock market be damned.

Typical was an article in yesterday's New York Times.  Titled "The Myth of Japan's Failure", the author Eamonn Figleton cites numerous statistics and anecdotes to bolster his contention that Japan's economic condition is actually better than portrayed in the West.  Here's an excerpt:

...By many measures, the Japanese economy has done very well during the so-called lost decades, which started with a stock market crash in January 1990.

By some of the most important measures, it has done a lot better than the United States. Japan has succeeded in delivering an increasingly affluent lifestyle to its people despite the financial crash. In the fullness of time, it is likely that this era will be viewed as an outstanding success story.

http://www.nytimes.com/2012/01/08/opinion/sunday/the-true-story-of-japans-economic-success.html?_r=1&src=me&ref=general

Worth a read.

Japan's Fiscal Woes

Interesting piece in today's New York Times about Japan.

I wanted to post it because it presents a good counter-argument to my semi-bullish comments earlier this week about the Japanese stock market.

(Let it be noted that Random Glenings tries to look at all sides of an issue!)

While most of the talk in the United States naturally focuses on our fiscal debt woes, Japan's are in some way even worse.

Ever since the Japanese bubble burst in the late 1980's, successive Japanese governments have attempted to reinvigorate their economy through massive fiscal stimulus packages.

Unfortunately, these attempts have been largely unsuccessful, but the debt burden continues to grow.

You wouldn't know it from Japanese interest rates. The 10-year Japanese government bond yields around 1.1%. With Japan trapped in a deflationary spiral, any sort of positive return is attractive to investors.

In addition, Japan is a country of savers. Unlike the U.S. - where spending and credit are viewed as a birthright - the typical Japanese citizen reacts to a slower economy by saving more. 95% of the Japanese fiscal debt burden is held by Japanese citizens, which makes it less vulnerable to outside creditor pressures.

Today's article suggests that this might begin to change:

...the numbers are frightening, especially given Japan’s lack of political leadership around fiscal issues. Government debt stands at about 1,000 trillion yen ($12 trillion), with gross borrowings of around 200 percent of gross domestic product. The productive means to pay off those liabilities are shrinking as Japan’s average age creeps toward 50. Thanks to scant immigration, the country also loses one million people a year.

Could Japan’s Debt Lead to a Crisis? - NYTimes.com

The article goes on to describe a scenario where the Japanese might need to start relying on foreign capital to finance its debt. This in turn could force interest rates higher, and push the Japanese fiscal deficit even higher.

As the Times notes:

If non-Japanese creditors demanded higher yields to compensate for low growth, the country’s dependence on short-term borrowing would quickly lead to spiraling debt service costs. Even a 5 percent haircut on government debt would equate to $600 billion.

Few have pockets that deep. Europe’s resources are tapped out on its problems. America is struggling, and would be even more so if Japan dumped the almost $1 trillion in United States Treasuries that it holds. The only sizable pool of capital available would probably be Chinese.

Sobering thoughts.

Goldman Sachs: "Japan equities set to rally back to pre-crisis highs"

Kathy Matsui of Goldman Sachs wrote a bullish piece on the Japanese stock market in yesterday's Financial Times.

Japan, of course, is currently mired in attempting to recover from the disastrous aftereffects of the earthquake and tsuanmi. First quarter GDP was -3%. Electricity remains in short supply, and many businesses have cut back production. The response of the government has been widely criticized, and Prime Minister Kan has been scrambling to contain the political damage.

And yet, as Ms. Matui writes:

Compared to the 1995 Kobe earthquake, when price to earnings multiples traded at 77 times, the full year p/e {for the Topix} stands at a more globally comparable 13 times.

For reconstruction, the government has approved a $50bn supplementary budget, and a second budget totalling $125bn is expected this summer. Since the earthquake, the Bank of Japan has conducted sizeable fund supply operations and expanded its asset purchase scheme by 14 per cent to $500bn. The BoJ has stated that, if necessary, it will take further steps to ease policy.

FT.com / Markets / Insight - Japan equities set to rally back to pre-crisis highs

The Nikkei is currently trading at a lower multiple, and offers a higher dividend yield, than the S&P 500, and yet the Japanese stock market has lagged most of the global stock markets.

I'm not totally convinced that this is the time to jump into the Japanese stock market - even the bullish Ms. Matsui doesn't think that the Nikkei will start to move until the fall - but I like the concept.

Japan is full of world-class companies, and its famous work ethic remains intact despite 20 years of economic malaise. With the government poised to throw massive resorts into rebuilding, I am confident that Japan will begin to show signs of recovery by this fall.

The question is: When do you start buying Japan?

G7 Central Banks "Carry" Markets Higher

I've seen very little written about the Japanese yen "carry trade" in the US press, but the Financial Times has done a nice job of following the story.

I first posted about the carry trade last week. Since then, the yen has weakened by 9%, and markets around the world have generally strengthened. If this trend continues, it could turn into a major story in the global markets in the next few months.

Background: the carry trade is nothing more than a strategy where an investor borrows funds in a low rate country like Japan and invests in other global assets such as higher-yielding bonds; commodities; or stocks.

The major risk to the carry trade (besides the leverage) is that the currency markets work against the investor.

However, when the G7 central banks (including the Federal Reserve) intervened in the currency markets a couple of weeks ago to weaken the yen, this signaled to the world that the yen strength would not be allowed.

Here's an excerpt from today's FT:

Analysts say that the move {by the G-7 central banks to weaken the yen}, as well as a belief in the financial markets that G7 policymakers will intervene again if necessary to cap fresh yen gains, has spurred investors to resume using the yen as a funding vehicle for carry trades.


FT.com / Currencies - Yen back in favour for carry trades

Crisis in Japan Spurs U.S. Investors to Buy the Nikkei

Americans are, in general, a pretty optimistic people.

Maybe it's the fact that most of our ancestors left their native lands for the U.S. in search of a better life. Or maybe it's the fact that most of the major wars that have occurred over our country's history have largely occurred outside of our shores.

Whatever.

Here's a recent example:

Japan is a difficult place to be right now, to put it mildly:

• Radiation concerns have now spread to Tokyo, where citizens are being advised to avoid tap water for their infants;

• The nuclear plants in Northern Japan continue to verge on the edge of disaster, although there has been some encouraging news recently;

• The Japanese government just doubled its estimate of the cost of rebuilding the infrastructure lost in the tsunami, to almost 4% of GDP;

• Rolling blackouts are now expected to the norm through at least the summer months;

• And the death toll keeps rising.

So what's the reaction of U.S. investors?

Buy stocks, of course!

From Warren Buffett to the smallest retail investor, there seems to be the perception in this country that Japan is the overseas market of choice. As this morning's New York Times explains:

Even as the aftershocks from the earthquake pushed financial markets sharply lower last week, American investors poured $1.2 billion into Japanese equity exchange-traded funds, or E.T.F.’s., according to new data. It was the biggest weekly inflow on record, a trend suggesting that some investors are already betting that the crisis may be just an interruption to a market rally.

U.S. Investors Pour Money Into Japanese E.T.F.’s - NYTimes.com

It will be interesting to see how this Japanese stock market interest works out.

Before the tsunami there had been some discussion that Japan was an interesting investment idea mostly based on its low relative valuation, so perhaps the U.S. investors' collective instincts are correct.

On the other hand, I suspect that patience and a long-term investment horizon will also be required to make Japanese stocks work well for U.S. investor - and we Americans are not known for our patience.

Rebuilding Japan

The news from Japan seems a little more encouraging this morning, but it's way too early to say that the worst of the nuclear crisis is over.

In addition, the enormous task of helping the victims of the tsunami is only beginning.

Still, as an investor, it is not too early to think about what will happen after the crisis abates in Japan.

Japan is the third largest economy in the world, populated by a very smart workforce and world class companies. Economic growth for the last 20 years has been anemic as the country still recovers from the excesses of the last 1980's but it is still a very rich country.

Japan has experienced natural disasters before, like the Kobe earthquake in 1995. They have shown themselves to be incredibly resilient, and I have no doubt that they will emerge stronger from the horrible events of the past few weeks.

Barclays estimates that the cost of Japan's recent disaster will be in the neighborhood of $60 billion to $120 billion. However, if the Japanese authorities are able to contain nuclear damage, it could very well be that the cost comes in at the lower end of these estimates.

This morning's Financial Times notes that the eventual cost of the Kobe earthquake reconstruction was around $120 billion, but it appears that this time around there are much fewer damaged buildings, which again is cause for hope.

Japan can afford this bill, as staggering as the numbers are. Even the upper end of the Barclays estimates is around 2% of Japanese GDP. In addition, the Japanese government was already on the verge of yet another stimulus plan, so in a sense they were already planning to spend this money.

I'll be writing more about this topic in the days ahead, but at this point it seems likely that US industrial companies are likely to be bigger winners.

Despite the coordinated intervention of the G-7 earlier this morning, the yen still stands at 15 year highs relative to the dollar. US companies will be offer incredibly competitive pricing to help rebuild Japanese infrastructure.

In addition, the world has suddenly become anti-nuclear. How long this sentiment persists is obviously unknowable at this point - particularly since nuclear offers clean reliable power to many parts of the world - but new power plants will need to be built. Companies like General Electric should benefit (along with other industrial companies like Siemens from Germany).

I've been slowly adding to positions in industrial companies in client portfolios this week, and will probably continue to add next week after I've had the chance to do more reading this weekend.

In the meantime, let's hope and pray that they get those plants under control.

Deflating Inflation Expectations

Talk of inflation seems to be everywhere these days.

Clients and analysts point to soaring commodity prices, including oil, that inflation is finally reappearing after years of being dormant. The bond market is also cited as sniffing inflationary pressures, since interest rates have risen in the last few weeks (but are unchanged from a year ago).

Still, I don't agree, and I thought Fed Chairman Bernanke did a good job yesterday discussing price pressures.

Bernanke (who is a pretty fair economist, after all) noted that most measures of inflation in the United States do not show any evidence of rising, but are certainly evident in the emerging markets:

"The inflation is taking place in emerging markets because that's where the growth is. That's where the demand is. And that's where, in some cases, the economies are overheating."

In the U.S., on the other hand, there is too much excess capacity, and too many unemployed workers, for any serious inflationary pressures to take place.

That was the point also raised by The Economist on its blog. Not only does the magazine dismiss the idea that the U.S. (or the U.K., for that matter) should be concerned by rising commodity prices, it also argues that any premature tightening of monetary policy could have disastrous consequences:

Just as the plunge in the price of oil in 1998 did not signal deflationary pressure in America, its rise today does not signal inflationary pressure here, unless it works its way into expectations and wages, of which there’s no sign yet...

...In fact, it could do the opposite: by draining more American purchasing power to overseas suppliers, higher oil prices leave less money to spend on stuff made in America. (America is a net food exporter so higher food prices are positive for American growth.) If the Fed were to tighten monetary policy today in response to Asia’s inflation problem, it could be the opposite of the mistake it made in 1998, compounding a deflationary shock at a time when the economy is significantly below potential.

Commodity prices: Inflation lessons from the Asian crisis | The Economist

Inflation can be a scary thing for the economy, and it is right that policy makers remain vigilant to make sure that we do not return to the high inflation days of the 1970's.

On the other hand, deflation can be even worse - just look at Japan, which remains stuck in an economic malaise that has now lasted more than 20 years. Premature tightening of monetary policy in Japan has occurred several times over the last couple of decades, and each time the policy changes had to be reversed.

Japan: Deflation + Downgrades = Good Stock Market

S&P downgraded Japan's credit rating yesterday citing, among other factors, the fact that Japan's ratio of government debt to gross domestic product is now above 100% (and rising).

The downgrade is somewhat symbolic, it would seem, since most of Japan's deficits are financed by domestic savings (unlike other countries, like the U.S., which rely on the kindness of strangers to finance their profligate ways). The S&P action sent a shiver through the credit markets.

Deflationary pressures, meanwhile, show no sign of abating, despite the government trying everything in the Keynesian playbook to try to get prices moving higher. Japanese 10 year government bonds offer a whopping 1.2% yield.

The employment outlook for younger Japanese is depressing, to say the least. Older Japanese workers - whose pensions and savings have been decimated over the last 20 years - have been reluctant to retire, and opportunities for college graduates are limited.

This morning's New York Times carried a long piece about the difficult employment outlook for even the most talented Japanese students:

Last year, 45 percent of those ages 15 to 24 in the work force held irregular {temporary} jobs, up from 17.2 percent in 1988 and as much as twice the rate among workers in older age groups, who cling tenaciously to the old ways. Japan’s news media are now filled with grim accounts of how university seniors face a second “ice age” in the job market, with just 56.7 percent receiving job offers before graduation as of October 2010 — an all-time low.

“Japan has the worst generational inequality in the world,” said Manabu Shimasawa, a professor of social policy at Akita University who has written extensively on such inequalities. “Japan has lost its vitality because the older generations don’t step aside, allowing the young generations a chance to take new challenges and grow.”

http://www.nytimes.com/2011/01/28/world/asia/28generation.html?_r=1&hp

So what does the Japanese stock market think of all of this?

A savvy client sent me this piece yesterday from Reuters:

Nomura's new Japan stocks fund draws strong demand

TOKYO Jan 27 (Reuters) - A new Nomura Asset Management mutual fund that invests in undervalued Japanese equities has attracted $887 million worth of retail money, an official from the fund's distributor Nomura Securities (8604.T) said on Thursday...

That was more than double the amount of last year's top newly launched fund, which was offered by Daiwa Asset Management and totalled 34.5 billion yen, data from fund research company Lipper showed.

"The stock market is expected to be in an upward trend for a while and there were many investors wanting to benefit from that," the official at Nomura Securities said....

...Japan's Nikkei benchmark average .N225 has jumped about 10 percent over the last three months, outperforming a 7.7 percent rise for the Dow Jones industrial average .DJI and a 2.2 percent rise for Hong Kong Hang Seng Index .HSI, Thomson Reuters data shows.

It is almost axiomatic that economic data and stock market performance do not mirror each other, and Japan seems to be the latest example.