International investors who propelled the biggest rally for Japanese shares since 1987 would have earned almost as much in the Standard & Poor’s 500 Index once the yen’s 16 percent tumble is taken into account.
The Topix Index, the country’s broadest equity measure, has climbed 41 percent in the 74 days since the rally began in November. After adjusting for the yen’s depreciation against the dollar, the return shrinks to 18 percent, or three percentage points more than the S&P 500, according to data compiled by Bloomberg. This year’s 18 percent advance in the Nikkei 225 Stock Average (NKY) falls to 6.8 percent in dollar terms, less than the 8.8 percent increase by the U.S. benchmark index.
Foreign investors who bought a net 4.19 trillion yen ($43.9 billion) during the rally’s first 16 weeks are repeating a pattern that has occurred during advances since at least 1997. The erosion highlights the hazards of the world’s third-largest equity market, where prices have moved in the opposite direction of the yen 67 percent of the time the last four months.
“People just simply keep looking at the return and not paying attention to the risks,” Malcolm Polley, who manages $1.1 billion as chief investment officer at Stewart Capital Advisors LLC in Indiana, Pennsylvania, said in a March 6 phone interview. “You’re trying to make your money on the currency side and the market side, but the outcome is only good if you make the right call on the market and on the currency.”
Stocks in Japan advanced last week, with the Topix rising 3.7 percent, the 16th gain in 17 weeks. The Nikkei 225 Stock Average regained its level from before the collapse of Lehman Brothers Holdings Inc. in 2008. The S&P 500 increased 2.2 percent to 1,551.18, within 1 percent of its record, while the Dow Jones Industrial Average surpassed its all-time high.
The yen retreated 0.1 percent to 96.08 per dollar at 4:18 p.m. in Tokyo, near the lowest level since August 2009. The Topix climbed 1.9 percent to 1,039.98 and the Nikkei 225 (NKY) advanced 0.5 percent to 12,349.05.
Currency losses during Japanese rallies in 1989, 1996 and 2007 cut U.S. investor returns by an average 22 percentage points, data compiled by Bloomberg show. The yen has dropped the equivalent of 0.2 percent every day since November as Prime Minister Shinzo Abe called for unlimited monetary easing and a doubling of the Bank of Japan’s inflation target.
Foreigners have been net buyers of Japanese stocks every week since the Topix rally began, while domestic investors were sellers until January, data compiled by Japan Exchange Group Inc. and Bloomberg show. Purchases by all investors fell for a second month in February.
More than $500 billion has been added to Japan share prices. The Topix rally since November is the best for a developed country on a local-currency basis, exceeding 23 other benchmark gauges. While Japan’s $3.93 trillion market capitalization is the world’s second-highest, the decline of the yen means that it’s still below the level it was before the country was struck by a record earthquake two years ago.
Brokerages have led the advance as average volume on the Tokyo Stock Exchange surged 65 percent compared with its level through last year. Nomura Holdings Inc., the nation’s largest, climbed 97 percent. Daiwa Securities Group Inc., the No. 2, jumped 104 percent.
Mazda Motor Corp., which gets 77 percent of sales outside Japan, surged 190 percent since Nov. 14 as the falling currency increased the value of overseas revenue when repatriated. Toyota Motor Corp., the country’s biggest company by market value, climbed 60 percent.
All 33 industries on the Topix have advanced, with just 45 of the gauge’s 1,697 companies declining. Airlines have been the worst performers as a group, adding 16 percent. Gree Inc., a social-network game operator that’s owned by Japan’s youngest billionaire, dropped 23 percent for the biggest decline on the Topix after cutting its profit forecast amid delays to new- product releases.
The Topix is trading for 20.7 times reported earnings, up from 14.33 on Nov. 14, the day the elections that brought Abe to power were announced. That compares with 15.3 for the S&P 500 (TPX) and 22.5 for the Stoxx Europe 600 Index.
Abe, who took office Dec. 26, has called on the BOJ to take additional steps to end more than a decade of deflation and last month passed a 13.1 trillion yen extra budget. The economy grew at an annualized 0.2 percent last quarter after shrinking 3.7 percent the three previous months, the worst since the 2011 earthquake, revised government data show.
Abe nominated Haruhiko Kuroda last month to lead the central bank, prompting further speculation of increased stimulus if he wins parliamentary backing to take over on March 19. Yields on five-year government bonds hit a record low of 0.095 percent March 4 as Kuroda testified at a confirmation hearing before Japan’s lower house of parliament.
“I would like to make my stance clear that we will do whatever we can do,” Kuroda, president of the Asian Development Bank, said at the hearing in Tokyo. The central bank should consider buying more assets, including long-term bonds, he said.
Easier monetary policy will weaken the yen further, diminishing overseas returns, according to Wayne Bowers at Northern Trust Corp., which has $758.9 billion under management. Policy makers next meet on April 3 under Kuroda’s leadership. The bank kept its asset-buying program unchanged at 76 trillion yen on March 7.
Stocks and the yen are going in opposite directions by the most in 25 years. The correlation coefficient, which measures how much two assets move together, was negative 0.44 in February, the lowest since June 1988, according to data compiled by Bloomberg.
Declines in the Japanese currency reduced the Topix’s 70 percent advance in the last two years of the 1980s to a 45 percent gain, according to data compiled by Bloomberg. In 1996, a 44 percent return dropped to 11 percent, while the 136 percent advance from 2003 to 2007 lost 7.3 percentage points, data compiled by Bloomberg show.
“Currency risk is now a big concern for asset owners,” Bowers, the London-based chief executive officer for Europe, the Middle East, Africa and Asia Pacific at Northern Trust, said in an interview March 6. “They can get the right call from an asset allocation perspective in terms of market positioning and then because of the currency moves depending on their hedged versus unhedged position, that move is either diluted or increased.”
While yen weakness can cut profits for foreign investors, bearish options bets on the currency are often used to protect against fluctuations and lock in returns, said Mikio Kumada, a Hong Kong-based global strategist for LGT Capital Partners.
“Those who bought the equity market on the view that the yen is falling would be stupid not to hedge it,” Kumada said in a phone interview March 7. LGT oversees more than $20 billion. “It has a small cost, but it’s not significant.”
Exchange-traded funds such as the $4.7 billion WisdomTree Japan Hedged Equity Fund (DXJ) neutralize the risk of yen fluctuations for overseas money managers. Average volume in 2013 climbed to more than 10 times the mean during last year, according to data compiled by Bloomberg. The fund rose 15 percent this year compared with an 8.3 percent advance on the S&P 500.
Traders betting on declines borrowed and sold short more than 1.1 million shares of the WisdomTree ETF between Jan. 31 and Feb. 15 and almost 18 million shares of the iShares MSCI Japan Index Fund, according to data compiled by the New York Stock Exchange. The increases were both among the 10 biggest on a percentage basis, the NYSE said.
Short selling in Tokyo fell to 12 percent of total turnover on March 8, the lowest level since the Tokyo Stock Exchange began releasing the data in October 2008.
Japanese investors, immune from yen fluctuations, are starting to return to the market. Individuals added 4.9 trillion yen to assets held by Nomura in January, the biggest monthly gain in at least a decade. The increase took the total of so- called retail assets at the brokerage to 78.5 trillion yen, the highest since December 2007.
Accounts at Monex Securities, the fifth-biggest brokerage by revenue, increased by 14,588 in January, compared with an increase of 413 in October, before the rally started. Account additions more than doubled in the same time period for Matsui Securities Co., the country’s most profitable web-based brokerage, and Kabu.Com Securities Co. (8703), controlled by Bank of Tokyo-Mitsubishi UFJ Ltd.
Individual investors may not be enough to drive the market, if history is any guide. They were buying stocks as the Topix dropped 61 percent in the two years through March 2009. Before that, investors sold equities for the four years through 2007, while the Topix soared 132 percent.
U.S. investors increased their holdings of H2O Retailing Corp., the Osaka-based company that operates railway terminal stores, by 3.5 percentage points in the past 12 months, according to data compiled by Bloomberg. While the stock is up 7.3 percent since November, investments converted back into dollars have lost 9.3 percent.
Calbee Inc., the Tokyo-based snackmaker, also lost money for U.S. investors, with its stock up 12 percent in yen and down 5.6 percent in dollars. Americans own 18 percent, up from 9.1 percent at this point last year, data show.
Cosmos Pharmaceutical Corp. has 27 percent U.S. ownership, up 6.3 percent from March 2012, data compiled by Bloomberg Show. The drugstore operator’s advance fell to 28 percent from 52 percent with currency adjustments.
“This rally has been predicated on weaker yen, and I think those trends are still in place,” Russ Koesterich, the global chief investment strategist at BlackRock Inc., said in a March 6 phone interview. The New York-based company is the world’s largest money manager with $3.8 trillion in assets. “For longer-term investors, having a big position in Japan, that’s still a big question mark.”
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