Business / Financial Markets

Biggest stock disconnect with JGB yields in 23 years reveals Kuroda's heavy hand

by Anna Kitanaka and Shigeki Nozawa

Bloomberg

The weakest correlation between Japanese bond yields and stocks in 23 years is showing how dependent the nation’s markets have become on central bank support.

The 60-day measure tracking moves between the Topix stock index and the 10-year benchmark government bond yield fell to negative 0.33 on Wednesday, the lowest since 1992 and below the 1 level that would represent lockstep moves. The last time the relationship broke down, in April 2013, the Topix fell for four straight months, the longest since the rout triggered by Lehman Brothers Holdings Inc.’s collapse in 2008. A similar pattern can also be seen in December 2010 and February 2007.

A lack of market response to the falling correlation illustrates how the BOJ’s unprecedented stimulus is breaking down the norms of the market, where stocks and sovereign bond yields tend to rise in response to positive economic news and fall during hard times. A Bank of America Merrill Lynch index measuring Japan’s sovereign debt has returned about 5 percent since Prime Minister Shinzo Abe came into power in December 2012, while the Topix has surged about 90 percent.

“Certainly in the past, the correlation declining or reversing didn’t last long,” said Hidenori Suezawa, a financial market and fiscal analyst at SMBC Nikko Securities Inc. in Tokyo. “This time, the BOJ’s buying is happening at an unprecedented level, and they’re not going to throw that away for now, which will keep the market from collapsing.”

The correlation between the stock gauge and 10-year JGB yields fell to negative 0.13 on April 4, 2013, the day BOJ Gov. Haruhiko Kuroda announced his unprecedented plan to double the nation’s monetary base.

After the correlation measure fell to 0.04 in December 7, 2010, the Topix slumped 26 percent from the intraday-peak reached in Feb. 17, 2011, through March 15, 2011 — four days after the offshore Great East Japan Earthquake and tsunami devastated the northeast. Similarly on Feb. 28, 2007, the reading declined to 0.09 and the stock benchmark slid about 60 percent over the next two years amid the global financial crisis.

Kuroda is trying to artificially boost prices in Japan by increasing the monetary base, a measure of the amount of money in the economy, by about ¥80 trillion ($671 billion) a year, mainly through buying government debt. He also pledged on Oct. 31 to increase purchases of Japanese exchange-traded funds to about ¥3 trillion a year from ¥1 trillion. In Europe, the correlation between moves in the Euro Stoxx 50 Index and a gauge tracking the region’s bond prices, which move inversely to yields, has reached its highest level in almost two years.

“Higher stocks with low yields, or falling stocks with rising yields is a typical phenomenon when there’s excess money from central bank easing,” said Toru Suehiro, an economist at Mizuho Securities Co. in Tokyo. “If they moved based on fundamentals such as the economy or consumer prices, then the correlation should go back to higher stocks, higher yields.”

Not everyone agrees that Japanese stocks are safe from reversing. Nader Naeimi, Sydney-based head of dynamic asset allocation at AMP Capital Investors Ltd., says that bond yields are now rising even though economic growth isn’t there to support the move.

“The Topix is vulnerable,” said Naeimi, who helps oversee $124 billion for AMP. “The equity market has been rallying for so long now. You also have this mismatch with yields up but not matched with stronger regional growth.”

Tomomi Yamashita, a fund manager in Tokyo at Shinkin Asset Management, which oversees the equivalent of $6.3 billion, expects further gains in stocks. Not only has the BOJ and public pension funds expanded their purchases of local equities, but earnings are also recovering, and that will act as a support for equities, he said.

Analysts estimate profit for companies on the Topix to grow 16 percent in the next year, more than double the pace for those on the Standard & Poor’s 500 Index, data compiled by Bloomberg show. Ten-year JGBs are forecast to yield 0.56 percent in the second quarter of 2016, according to a Bloomberg survey of analysts.

“Once the earnings season is over and we see we can have hopes for profits, stocks should move in a bullish way,” Yamashita said.

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