Market Review: Japan

The rally in global equity markets which began in early March continued apace during May. Japan participated fully, with the TOPIX index rising 7.2% in yen and 10.9% in USD, reflecting a strengthening of more than 3% in the yen. Smaller companies performed better still, turning in a yen return of 14.4%, which translated into a US dollar gain of around 18.3%. It is important to note that the rally has now delivered exceptional returns from the lows of more than 30% for large companies, and more than 40% for small companies.

The stock markets in Japan have been influenced as much by global trends as they have by what is happening domestically. The power of the rally is a symptom of how oversold markets became in the economic gloom of February. Although the banking system no longer appears terminal, precipitous declines in exports showed that the transmission mechanism from the financial economy to the real economy was working smoothly. Needless to say, activity simply cannot drop for long at the rate seen in the first quarter of the year. Signs of so called green shoots were bound to emerge, and so they have. These result principally from the end of a violent cycle of destocking, as companies have tried to align their inventories with the new economic reality. There may also be some signs that the Chinese economy has reoriented itself to domestic activity and that this shift is already leading to a pick up in demand for capital goods – a key export sector for Japan. The jury is still out on how sustainable these green shoots are and the markets may be running too far ahead of reality, in particular as deflationary forces are clearly visible even as wages are falling and the output gap is rising.

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