“Let’s do it,” Yoshihiko Noda, Japan’s prime minister, said Nov. 14, during a political debate with his opponent Shinzo Abe. Noda meant that it was time to dissolve parliament and hold a new election. Investors heard it as the kickoff to a rally that hasn’t stopped, with the Nikkei 225 stock index gaining more than 50 percent and returning the market to levels not seen since before the 2008 financial crisis. The Nikkei’s best performer since Nov. 14, with a 194 percent gain through April 10, is Tokyo Tatemono, a real estate developer. Nomura (NMR), the $445 billion financial-services company, has advanced 146 percent.
Politics and prices are deeply entwined in the rally. Abe and his Liberal Democratic Party won a landslide victory in December on the strength of his “Abenomics” stimulus proposals, which aim to jolt Japan out of decades of lethargy. Even at a four-year high of just over 13,000, the Nikkei is worth only a third as much today as it was at the end of 1989, when Japanese corporations seemed poised to take over the globe. What felt like a permanent recession followed, with years of deflation and anemic growth.
Abe has promised to spend his way out of the doldrums, announcing a 10.3 trillion yen ($103 billion) stimulus package in January and installing a Bank of Japan governor who has enthusiastically agreed to double inflation targets to 2 percent a year. That has weakened the yen, which now trades at the lowest level against the dollar since April 2009—great news for Japanese exporters such as Mazda and Sony (SNE), whose products look more appealing to global buyers at lower prices.
The strong government action has led some investors to believe that this bull market is different from the succession of surges in the 1990s and 2000s that turned into selloffs. “It’s a very coordinated effort on multiple fronts,” says Audrey Kaplan, head of international equities at Federated Investors (FII). “That is something that is unique.” Stocks accelerated their gains on April 4, when Haruhiko Kuroda, Abe’s choice to lead the country’s central bank, announced he would double the currency in circulation by purchasing 7.5 trillion yen ($75 billion) in bonds each month. For 15 years deflation has acted like a narcotic in the Japanese bloodstream: Falling prices mean consumers delay purchases of homes and TVs because they will always be cheaper in the future. Ending that cycle and establishing moderate levels of inflation are seen as essential steps in rebooting Japan.
The challenge for the Abe and Kuroda regime is to improve the fundamentals of the economy. The Bank of Japan’s yen policies just might do that, says Mikio Kumada, a global strategist with LGT Capital Partners, who is based in Hong Kong. “The income and wealth effect from a weaker yen”—the perception that one is richer with more money, even if the bills are worth less—“should help promote the large and stagnant domestic market,” Kumada says. “If reflation succeeds, exports will do well. But in many cases, domestic sectors—real estate, banks, possibly construction—could do even better.”
As of March 3, 17 strategists tracked by Bloomberg said they expected the Nikkei to end the year at 10,418, essentially flat from the end of 2012. When a market gets this hot this quickly, there is a corresponding risk of a pullback, as winners are tempted to sell and lock in their profits. That’s even more true in Japan, where the market has a high level of foreign investment. Overseas money is seen as more fickle, and the prospect of a falling yen makes it more attractive to yank money out now, before it’s worth less. For American investors, the Nikkei’s return over the course of the rally is cut to 20 percent after factoring in the yen’s depreciation. (Some investors try to offset currency declines when they buy Japanese stocks by betting against the yen.)
Abe campaigned on the slogan “Take back Japan.” For now, it’s working. Still, a full market recovery will take some time. Even if the Nikkei gained a scorching 25 percent a year, it would not reclaim its all-time high until the end of 2017.