Japan's Nikkei Index Sets Another Record High. Will the Topix Follow?
Unlike the bubble-era levels of the 1980s, there is no sign the Nikkei 225 is overheated. So when will the Topix break its own record?
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The Nikkei 225 set a fresh all-time high on Tuesday, the third straight trading day in which the index has finished above the levels it set during Japan’s 1980s asset bubble.
Yet isn’t this a Japan that is in recession? An economy that just surrendered the No. 3 spot in terms of total size, behind the United States and China, to Germany? What gives?
The Nikkei finished Tuesday at 39,239.52, up a slim 0.01%, so it surely won’t be long before it breaks above 40,000. Traders cheered last week as the blue-chip index first overtook its prior record level of 38,957.44, set on the last trading day of the 1980s, Dec. 29, 1989.
For many years, it seemed impossible that the Nikkei would ever reclaim that mark. The 34 years it has taken to recover is a full decade longer than it took Wall Street to rebound from the 1929 crash and the Great Depression.
The Nikkei, which shares similarities with the Dow Jones Industrial Average in its makeup, has had several nadirs since then. It fell below 8,000 both in the wake of the dot.com bubble in 2003, and again in 2009, after the Global Financial Crisis, when it sank as low as 7,021.
To see the index stand at five times those levels is a complete sea change on Japanese markets, which have wandered through three “lost decades” in terms of growth, only to find their footing with a cheap currency and extremely low borrowing costs, and at a time when many global allocators have been eager to shift their Asian exposure out of China.
Valuations of Japanese equities are far from extended, unlike in 1989, when 15 of the 20 largest companies globally by market capitalization were based in Japan. Now, the price-to-earnings (P/E) ratio based on 12-month forward earnings stands at 15.9x, within the 12-17 range seen in the last decade.
As a result, “we think the market does not look overheated,” Nomura Securities head of macro strategy Yunosuke Ikeda recently wrote in a note to clients. “Unlike in 1989, this time around high equity prices are backed by corporate earnings.”
Psychological boost
It is a huge boost to Japan's morale to see the Nikkei break new ground. Ever since the 1980s bubble burst, every rally, every jolt of economic good news, was framed in terms of that period of excess, when at a nominal valuation the land under the imperial palace in Tokyo was worth more than all the real estate in the state of California.
Such valuation obviously did not make sense. As the bubble burst, Tokyo stocks plunged some 70% and Japanese property lost 80% of its value in the 1990s. Japan also entered a negative spiral of descending prices, deflation and intermittent recession.
It never felt like Japan was doing that badly when you visited the country. Its technological prowess continued, and many of its multinationals became truly global brands, with Toyota Motor (TM and T:7203), for instance, just behind General Motors GM for total U.S. market share, as well as being one of the largest producers of vehicles in the United States.
A weak currency has been benefitting the bottom line of such companies, magnifying profits when translated from U.S. dollars back to Japanese yen. The yen is now trading north of ¥150 to the U.S. dollar, levels similar to those early '90s dark times of the descent into deflation.
Japanese stocks are also reaping the rewards of corporate-governance reforms. The Tokyo Stock Exchange has set up a Prime categorization of companies that meet the highest standards of corporate governance and has been encouraging such companies to buy back shares and to unwind the complex structure of cross-shareholdings in strategic suppliers, banks or customers that had become common. Those strategic shareholdings still account for around 30% of all listed shares, so the ongoing process of streamlining those holdings will likely continue for several years.
The next important marker will be the moment when the broad-market Topix -- full name, the Tokyo Stock Price Index -- crosses its all-time high. It set that at 2,885 on Dec. 18, 1989. The Topix closed Tuesday at 2,678, so it’s still some distance short of the mark. Year to date, its 12.6% advance lags the 17.9% gain for the Nikkei, which is price-weighted and biased toward large multinationals. The Topix is weighted by free float and market cap and it tracks almost the entire Tokyo market via its 2,160 constituents.
Nomura currently estimates that the Nikkei will hit 43,000 this year and the Topix will crest to 3,025. The performance of individual stocks should track and be driven by earnings and fundamentals -- a very good sign.
While the yen looks likely to remain weak, market watchers such as Naka Matsuzawa, Nomura’s chief Japan macro strategist, caution against trading based on the justification of a weak currency. Look instead to profit growth and share buybacks as indicators of which Tokyo listings are likely to outperform as Japanese stocks continue to test new ground.
