Japan's Market: An Amazing And Ongoing Drama

The amazing rally in the Nikkei 225 hit its interim high on May 22nd, up 91.5% from its interim low in November of 2011. Even more astonishing is its meteoric 80.43% rise from its mid-November 2012 low. The steroid effect of massive monetary intervention has waned over the past ten sessions, and the index is now down 16.72% as of yesterday's close. That puts it about 3.3% from the traditional bear market 20% threshold.

What about Japanese government bonds? The closing yield of the 10-year bond on the day the Nikkei hit its 2011 interim low was 1.53%. It was cut in half to 0.75% a year later when the Nikkei hit its November 2012 low shortly before the steroid rally. The yield fell to its 2013 low of 0.44% on April 4th, the day that the Bank of Japan disclosed its radical redo of monetary policy. It rebounded to 0.94% on May 29th, and closed today 9 bps lower at 0.85%.

A Look at the Historical Perspective
Here's a quick review of the Nikkei 225, the 10-year bond and inflation over the past few decades.
The table below documents the advances and declines and the elapsed time for the major cycles in the Nikkei.

The Nominal versus Real Nikkei 225

For most major indexes, we expect to see a significant difference between the nominal and real price over a multi-decade timeframe. But Japan's chronic bouts of deflation have kept the two metrics rather tight. Note that I've used a log vertical axis for the index price to better illustrate the relative price changes over time.
Japanese Bond Yields: How Low Can They Go?

Government bond yields in many safe-haven countries have plunged since the Financial Crisis, although the US 10-year, now hovering around 1.9 percent, is well off its historic closing low of 1.43 percent set in July of last year. The lesson from Japan is that the trend toward lower yields can last a very long time. Here is an overlay of the nominal Nikkei (linear scale) and the 10-year bond along with Japan's official discount rate. The 10-year yield hit its all-time low in June of 2013, about 10 years ago, at 0.43%. It closed today at 0.85%.And here is a closer look at the
10-year yield over time (log scale).

I mentioned that 10-year record low of 0.43%. When the latest round of BOJ easing was officially announced on April 4th, the yield closed that day at 0.44 percent.

The consensus view of the Nikkei's massive rally since last November, and certainly one that I share, is that it was essentially a result of the market's response to rumors and news of the BOJ's plan for the latest easing of last resort months before its implementation, with the falling Yen as the key driver.
Note that the Yen hit its interim low on May 22nd, the same day the Nikkei hit its recent peak.

What we've seen in Japan is an amazing chapter in the ongoing drama of economics and the market -- a drama that no doubt has a lot more in store for us.