The Bank of Japan’s plan…

Last week the NASDAQ index reached its highest level since 2000.

It closed above 5,000 points.

Could that be the signal that the market has hit a top?

Or is it a sign that the market could push through to a new high?

Only time will tell. But the NASDAQ isn’t the only index to close at a multi-year high.

And this index could be much more important for Australia…

Japan’s Nikkei 225 index is up 120% since early 2012.

That beats the 73.5% gain for the NASDAQ, and a 45.3% gain for the Aussie S&P/ASX 200 index.

Japan is important for the Aussie market and the Aussie economy. Japan is Australia’s second biggest export market, after China.

But there’s another strong link between Australia and Japan. That’s the carry trade. It helped push the Aussie market to new highs during the 2000s.

The carry trade is where investors borrowed money in low interest rate Japan, and then bought high yielding assets in Australia.

That kept a lid on Japan’s market, as the money flowed overseas. But as interest rates fell around the world, money started flowing back to Japan. That has pushed Japan’s market higher.

So, will this trend carry on, or will it present opportunities if the trend breaks down and investors start ‘shopping’ elsewhere?

Was this the Bank of Japan’s plan all along?

Japan has kept interest rates low for nearly 20 years.

You can see on the chart below. The Bank of Japan cut rates to 0.5% in late 1995. The rate has been at that level or lower since then. It’s currently 0%:



However, the interesting factor isn’t so much Japan’s rate on its own, rather it’s the rate compared to other country’s rates.

For instance, in January 2008, Japan’s rate was 0.5%. At the same time, Australia’s interest rate was 7%.

That’s a 6.5 percentage point difference.

It’s no wonder traders were borrowing at close to zero and then parking their money in higher yielding Aussie bonds and stocks. It was as close as you could get to money for nothing.

Needless to say, as the Reserve Bank of Australia (RBA) started cutting rates in 2008 and 2009, the difference between Aussie and Japanese rates closed, and so the carry trade became less attractive.

It stayed that way until 2010, when the RBA increased interest rates. Aussie stocks left Japanese stocks behind, as an albeit smaller version of the carry trade played out again.

But since 2012 the carry trade has been well and truly off the table. That despite the Bank of Japan promising to more than double the money supply in order to boost its economy.

In years past, that would have got the carry traders excited, borrowing in yen and investing overseas.

But now, where’s the advantage? Since 2012, the trend has been for lower Aussie interest rates. Where the difference between Japanese and Aussie interest rates was 6.5 percentage points in 2008, it’s only 2.25 percentage points today.

Perhaps this was the Bank of Japan’s ploy all along.

No reason for the carry trade

If it was, it has taken them a long time to see it through to fruition.

It’s 20 years since the Bank of Japan cut rates to 0.5%. It’s 16 years since it first cut them to 0%.

But over that time, and especially since 2008, central banks around the world have cut interest close to zero, to zero, and in some cases to below zero.

So it’s no surprise that Japanese investors are keeping money at home. Why take the currency risk by borrowing in yen and then buying Aussie government bonds or stocks?

It doesn’t make much sense when they can keep their money at home and buy Toyota Motor Corp [TYO:7203] and get a 2.15% dividend yield.

Or what about Nissan Motor Co Ltd [TYO:7201] for a 2.54% yield.

What are we getting at?

The gist is that just because a market has hit a multi-year high, don’t assume that it’s the top of the market. For all the criticism of Japan’s economy, it’s still home to some of the world’s biggest brand names.

Is buying Japan now a lockdown value play? No. But it is a momentum play. Despite the high prices, Japan’s market could be one of the surprise performers for 2015.


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