Nikkei Soaring on Local amp Foreign Flows

Here are the realities of global capital flows into Japanese equities:

Weekly Japanese purchases of foreign stocks (red graph below) have reached a net negative ¥270 billion, which means Japanese investors were in fact net sellers of non-Japanese stocks. The figure is a slight decrease from the prior week’s ¥442 billion, which is the highest reading for net Japanese selling of foreign stocks on record.

Weekly Foreign purchases of Japanese stocks (white graph below) have hit a 9-year high of ¥1.12 trillion. Considering this figure is sufficiently near the 2004 record of 1.15 trillion and that foreign interest is merely starting, a new record high is imminent.

What’s Different this time?

The positive correlation between foreign purchases and the Nikkei is evident. Rising foreign demand for Japanese equities tends to boost the domestic index. But another important determinant of the index is Japanese flows. Note the 175% plunge in Japanese net purchases of foreign stocks from October 2012 to the first week of March 2013. Over the same period, foreign net inflows to Japanese stocks soared 550%.  It is no surprise that all the Nikkei’s 23% rally in 2012 began in mid October, coinciding with then candidate Shinzo Abe’s pre-election manifesto to reflate the economy and force the Bank of Japan into unlimited asset purchases.

Unlike in other periods, the current 6-7 month phase of Japan-bound investments stands out in terms of duration. Looking at the chart, volatility is rather noticeable.  Late Q1 2011 witnessed relatively sharp flows in the favour of Japan from local and foreign investors, but those were short-lived.

The Nikkei is already +17% this year, rallying more than any other equity index. This may sound excessive for three months, But as we indicated last week, the index is only 56% above its 2008 lows (aka generational lows), which compares to +120% for its global peers from their own generational lows. Considering that such moves are the result of PM Abe’s promise to reflate the economy, rather than the actual implementation of these programs, these gains could only be justified as PM abe has a 2% inflation target to achieve.