In June 2012, Japan was facing a ticking time bomb of enormous debt. Given the reliable pattern we've seen over the years by central banks, I didn't have to go too far out on a limb to predict “Massive Japanese Debt Monetization Is Coming - Yen to Be Devalued,” which then took place a few months later and sent the Japanese stock market off like a rocket.
After a huge 75% rally from November 2012 through May of 2013, the TOPIX (Tokyo Stock Price Index) has been largely consolidating since. Recent signs of life, however, suggest the TOPIX could be setting up for another strong run when looking at breadth indicators like the cumulative advance-decline line (ADL).
The ADL for markets often leads the underlining index as breadth typically narrows near tops and expands near bottoms. A perfect example of this is looking at the TOPIX over the last decade where the TOPIX is shown on the top panel and the TOPIX ADL is shown on the bottom panel below. During the 2006-2007 market top, while the TOPIX made a higher high in 2007, the ADL had already warned of a major market peak. Likewise, the ADL signaled a bottom was taking place in late 2011, early 2012 as breadth improved.
Fast forward to today and we see the ADL for the TOPIX has clearly broken out and is accelerating sharply higher while the TOPIX itself is more or less flat over the last year.
Source: Bloomberg
It could be that the Japanese stock market is beginning to discount further acceleration in the BOJ’s monetary policy. Similar to 2012, there is a massive skyscraper of Japanese debt maturing in the near future and given the declining purchases coming from Japanese households for Japanese bonds, the BOJ is likely to step in as the buyer of last resort.
A similar situation occurred with multiple rounds of quantitative easing (QE) in the U.S. where the Fed has acted as the liquidity spigot of last resort. If you wanted to know when QE would end or start, all you had to do was monitor commercial bank lending and know the Fed would do the opposite of commercial banks. When commercial bank lending began to stall in the second half of 2010 the Fed began to accelerate the growth in its reserves and then when commercial banks began lending at a faster clip in 2011, the Fed pulled back on the monetary reins. The cycle repeated when commercial bank lending growth stalled in 2012 and the Fed launched QE 3 and 4 going into 2013. Then when commercial bank lending growth bottomed late in 2013, we got the first “taper” announcement from the Fed.
The Ying and Yang of US Monetary Policy
Source: Bloomberg
In Japan we have a similar situation where the BOJ is picking up the slack from households instead of commercial banks. Japan has a well-known demographic issue in which the population ages 65+ (green line below) are expanding at a rapid pace from roughly 5% of the population in 1950 to a projected 40% around 2040 at the same time the working age population (15-64, red line below) is experiencing a rapid decline.
Source: UN
As the working age population shrinks so too will the available pool of earned income from that demographic that has traditionally purchased Japanese government bonds. At the same time, the swelling pool of those in retirement will now be drawing on their financial assets for support, which creates a huge shift in the supply and demand dynamics for Japanese government bonds.
It thus comes as no surprise that just as the outstanding Japanese household holdings of government bonds and T-Bills peaked that the holdings by the BOJ (red line below) has troughed and is accelerating sharply higher.
Source: Bloomberg
As mentioned previously, back in 2012 there was a massive amount of government debt maturing just before the central bank aggressively expanded its balance sheet. Looking at the current debt maturity for Japanese debt shows that of the 990 trillion yen in Japanese debt outstanding we have 29% of it maturing between now and the end of 2015 and 39% of it maturing between now and 2016.
Source: PFS Group
Waiting for a Catalyst
While there is the need for the BOJ to further expand its balance sheet to help meet hundreds of trillions of Japanese debt maturing in the near future, there has been some pushback within and outside the bank given the dramatic spike in inflation. For much of 2012-2013 Japan was battling mild deflation until the delayed effects from the devaluation of the yen began to take hold. From March 2013 the Japanese Consumer Price Index (CPI) rose from -0.9% to 3.7% by May of 2014. With the Japanese CPI rate having hit the highest level in nearly a quarter century, a pause was clearly in order as both the Japanese stock market and currency took a much needed breather.
However, the pause in the JPY/USD exchange rate suggests that Japanese inflation has likely peaked and may provide further cover for the BOJ to expand its balance sheet at an even more aggressive pace in the future. As seen below, the JPY/USD exchange rate leads Japanese inflation by several months and suggests the CPI rate should fall closer to 2% in the coming months.
Source: Bloomberg
Further cover for the BOJ to print will likely come from a stalling economy. Inflation trends typically lead Japanese consumer confidence by several months and suggest Japanese consumers begin to significantly sour in the coming months, potentially to levels not seen since the 2009 lows (note: Inflation in red shown inverted for directional similarity).
Source: Bloomberg
Should Japanese consumer’s moods turn south, so too would Japanese GDP as the two are closely linked.
Source: Bloomberg
In addition to a consumer retrenchment that would hit GDP, there would also likely be a retrenchment in Japanese manufacturing activity as the Japanese Tankan Business Conditions Manufacturing Index lags the trends in inflation by several months and suggests a sharp decline ahead (note: Inflation in red shown inverted for directional similarity).
Source: Bloomberg
Circling back to the Japanese TOPIX Index, the ADL has now recovered all of the 2006-2010 decline while the TOPIX Index itself is still lower by 37% and could have a substantial move higher over the coming year given the strength of stocks that make up the index. The potential catalyst ahead may be a lower inflation rate and a slowing economy that provides cover for the BOJ to act.
