Fed's Move is Incrementally Positive for Japanese Equities

Last November, we became more upbeat on Japanese equities from a cyclical perspective because Japanese stocks had become significant latecomers, and we saw the Fed beginning to implement its exit strategy while the Japanese government (and, reluctantly, the BOJ) was still fumbling for the accelerator to a sustainable Japanese economic recovery.

Most global investors agreed, pouring a net JPY2.8 trillion into Japanese equities from November into the New Year. In the last week of January and first week of February, however, foreign investors turned modest net sellers in a global dash-for-cash to trim risk profiles to account for Euro sovereign risk. But they should now begin returning to Japanese stocks as JPY begins to weaken again.

This is because the Fed’s move to gradually implement its exit strategy by raising the discount rate by 25bps is modestly bullish for Japanese equities because it will work to weaken JPY/USD rates. In addition, Japan’s exports to China and Asia are again surging off very low YoY comps, which noticeably boosted Japan’s October-December 2009 quarterly GDP.

On the other hand, Japanese equities still face domestic headwinds, not the least of which is the Hatoyama Administration and the BOJ singing off of different song sheets as to how to eradicate entrenched deflation in Japan.

Further, domestic financial institutions and corporates can be expected to continue dumping their trillions of yen in cross holdings, as the banks continue preparing for more stringent BIS capital requirements, and corporates move to adopt new international accounting standards. In addition, broker/dealers continue to unwind substantial amounts of Japanese equity prop positions.

That is why we use "incrementally positive". So far, these cross-currents have kept the Nikkei 225 in neutral territory, or right at 10,000 and 200-day MA support. If the Fed moves push JPY/USD a few more yen toward JPY100/USD, however, we would expect to see a commensurate positive reaction in Japanese equities, particularly among those stocks most sensitive to Asia demand and currency exchange rates.