Key Points
- The Bank of Japan’s stimulus program is Godzilla-sized.
- The program to grow the monetary base has had little lasting success, with economic growth remaining soft.
- The policy poses a rising risk of becoming a monster that wreaks havoc on the country as the Bank of Japan becomes the biggest owner of Japanese bonds and stocks.
Godzilla Resurgence, the latest version of Japan’s King of Monsters, is the highest grossing domestic film of the year in Japan and will be released in the United States this month. Lately, sequels seem to win out over new ideas; the same could be said for central bank policies in recent years. The Bank of Japan faces a rising risk that their policy has created a monster that may be getting harder to control.
On September 21, amidst talk of “helicopter money” and an increasingly difficult to manage policy, the Bank of Japan (BOJ) announced changes to extend their long-running economic stimulus program, already by far the largest in the world as a percentage of GDP. In fact, you could say the BOJ’s stimulus program is Godzilla-sized and may begin to pose an increasing risk to investors.
Source: Charles Schwab, Bloomberg data as of 9/29/2016.
At the current pace, the BOJ could own more than half of all Japanese government bonds and run out of bonds to buy from banks by the end of 2017. Addressing the scarcity issue, the BOJ announced a change to the program, in late September. Purchasing will be determined by whatever amount is necessary to stabilize longer-term bond yields around zero, rather than buy a preset amount each month.
The BOJ is also buying stocks, and is on track to become the largest stockholder in the world’s third largest stock market. The BOJ doesn’t acquire shares of companies directly, rather it buys them through Exchange Traded Funds (ETFs). Estimates of the underlying stock holdings of the ETFs owned by the BOJ reveal that the central bank is among the top three holders of more than 10% of Japanese stocks. By the end of 2017, the BOJ will be a top shareholder of more than half of all Japanese companies in the Nikkei 225 Index, according to Bloomberg.
Bank of Japan on track to become a top shareholder in more than half of Japanese stocks
Source: Bloomberg, data as of 8/14/2016.
The Bank of Japan increasingly risks becoming a “king of the markets,” the ultimate owner of most of the government bonds and corporate stocks in the country. This could pose several risks:
- Trading in Japanese government bonds has plunged, raising questions about the functional limits of QE.
- Market volatility may rise as the assets owned by the private sector decline. Companies that have a smaller percent of shares available to the public have historically tended to be more volatile.
- If, in the future, the BOJ chooses to promote social or economic goals and not simply act as a passive investor, sudden changes that could take place at companies may not be in the interests of other shareholders.
The upside for investors may seem to be the enormous buying that could push up asset prices. But, despite all the buying of Japanese stocks by the BOJ this year, it has not been a blockbuster year. In fact, Japan’s Nikkei 225 Index has posted a 4.5% total return for 2016 through the end of September, measured in U.S. dollars. This return lagged both the U.S. S&P 500 and broad MSCI All-Country World Index by about 2 percentage points. This is no surprise, since the Japanese stock market has behaved like the global financial sector, as discussed in the recent commentary Your portfolio may be less diversified than you think. Changes in interest rates have been a far more potent factor driving Japanese stocks than BOJ buying, at least so far.
Another sequel
The BOJ is delivering yet another sequel to their long-running stimulus program with little hope of successfully boosting long-term growth or inflation. Japan’s growth solution is more people, not more policy. Japan’s GDP for the past 10 years has been less than 1% a year, second only to Italy as the worst among the Group of Seven (G7) countries (United States, United Kingdom, Canada, Germany, France, Italy, and Japan). At first glance, it appears that the BOJ desperately needs to do something to drive greater growth. But GDP per worker in Japan is the second best of the G7, higher than Germany and second only to the United States. In Japan, it’s the demographic decline in workers that is limiting growth. The BOJ’s policy of expanding the monetary base has been a poor substitute for a shrinking number of people and poses an increasing risk to the markets.