Bill Jamieson: All eyes on Japan as markets begin recovery

Bill Jamieson
Bill Jamieson
Share this article
Have your say

JUST what is it that has been driving shares higher? Looking at the business background – the continuing carnage in the retail sector and fears of a “triple dip” recession – this seems the most unlikely background for a continuing rally in equity markets.

Dare we trust it? Should we be buying into this market? How much further might this rally go?

Last week, the FTSE 100 Index gained 33 points, or 0.5 per cent, taking it up to 6,154.41 – a rise of 17 per cent on the low last year of 5,260 and a new 12-month high.

London is by not alone. Markets around the world have also been rising strongly – and it is here we find the answer to the puzzle of a resurgent equity market against a backcloth of bleak economic news. In New York last week, the Dow Jones Industrial Average swept up 161 points, or 1.2 per cent, to 13,649. Markets in Frankfurt and Paris are close to 12-month highs. In Australia, the main index has hit a 12-month peak.

Arguably the most eyebrow-raising of all has been the resurgence of the Japanese stock market. Long a graveyard of recovery hopes, the Tokyo Nikkei 225 has enjoyed a powerful rally since early December and climbed a further 112 points (1 per cent) last week to close 31 per cent above its 2012 low.

The worldwide market rally has been driven by three factors. The first is a continuing commitment by leading central banks to continue their policy of monetary easing – in the words of European Central Bank president Mario Draghi, to do “whatever it takes”. The second is growing evidence that the US housing market – the source of the global financial crisis – is continuing to recover. And the third is reassuring data on China’s economy after fears last year it was heading for a major downturn.

All the worries and threats to this story are still in place. Indeed, seldom have recovery prospects had to battle with so many daunting problems. And it would not be at all surprising if markets suffer a pull-back in the weeks ahead after this strong advance.

But Guy Foster, head of global equity strategy at stockbroker Brewin Dolphin, said: “In the US, the housing market is creating wealth and real incomes are no longer being eroded by soaring commodity prices. In the eurozone, meaningful gains in competitiveness are occurring far faster than many economists predicted, resulting in increasing investment.

“Japan is seeking to address its long-term battle with deflation through a 10 trillion yen stimulus package and attempted devaluation of the yen. These factors will become more meaningful in the second half of 2013 and beyond.”

Arguably the biggest contributor to this improved sentiment comes from the world’s leading central banks. This has encouraged markets in the belief that there is unlikely to be any change in the ultra-low level of interest rates any time soon. Indeed, it is the impact of European Central Bank statements on market expectations that have done more to rally confidence in the eurozone than actual policy actions.

In America, policy action there has certainly been. The US Federal Reserve continues to buy $40 billion (£25bn) of US agency mortgage-backed securities a month in addition to $45bn of treasuries. This has helped to bring about a modest rise in US house prices, critically important in lifting household confidence.

But it is Japan where policy statements have had the most dramatic effect. December saw the election of a new prime minister, Shinzo Abe. In a bid to break a 20-year cycle of deflation and stagnant economic performance, he has promised firm and determined action with a massive fiscal stimulus and pressure for monetary easing.

The immediate effect has been to weaken the country’s notoriously high currency. The strength of the yen has done much to hurt exporters, driving up the price of Japanese exports against other Asian competitors. And as the yen has weakened, the stock market has strengthened.

Investors in Japan long used to years of deeply disappointing performance have enjoyed gains ranging up to 30 per cent in recent months. Last week the Nikkei 225 hit its highest level in almost three years.

Dare we believe it this time? Given the long history of previous false dawns, there are many who are sceptical – Abe’s ­programme still has to be endorsed in upper house elections due this summer.

And more will be needed than fiscal stimulus alone. As Andrew Milligan, head of global strategy at Standard Life Investments said in a recent interview, structural reforms are also needed to free up its financial and labour markets.

He said: “When you get big players like Panasonic and Sony beginning to implode under the pressures they’re facing, this is a very strong warning to the Japanese establishment that changes need to be made.”

But resistance may already be setting in. The yen decline was halted last week after comments from economy minister Akira Amari that an excessively weak currency could make imports too expensive. And there are fears that a prolonged yen devaluation could trigger a global currency war.

In that event, the great global stock market rally would be halted dead in its tracks.