Buying Nikkei Futures Priced in $USD

I tweeted on Thursday that I thought that there was a greater than expected chance for the Bank of Japan to positively surprise markets and increase its QE program. The BOJ did increase its QE amounts and I tweeted that I bought Nikkei futures as the market exploded higher.

I believe Japan’s 22 year secular bear market ended in November 2012 when the Nikkei rose by 85% in just 6 months. After 17 months of consolidation, Japanese stocks look ready to make another big move up.

Nikkei Long Term Chart-2

My bullishness on Japan rests mainly on Prime Minister Shinzo Abe’s determination to create inflation. As shown on the following chart, Japan has had virtually no inflation over the last two decades meaning that the BOJ has been unable to provide negative real interest rates for the Japanese economy.

Long Term Japan CPI & Interest Rates-2

When Abe was elected, he pushed for the BOJ to increase its inflation target to 2% and named Haruhiko Kuroda as new BOJ Governor. Kuroda, who is cut from the same cloth as Bernanke and Draghi, believes deflation must be fought off with aggressive monetary easing to raise long term inflation expectations. That, he argues, would lower real interest rates and encourage spending.

In fact, Kuroda had been arguing for the BOJ to adopt an inflation target a decade before it set one in January of last year and has spoken in favor of QE for years. And he lived up to his dovish reputation at his first meeting as BOJ governor by announcing that the BOJ was going to double the monetary base within 20 months.

Despite this, economists estimate that Japan’s inflation rate is likely to fall well below its 2% target by next year. The recent drop in oil prices is a further deflationary shock, but gave Kuroda an opportunity to add to stimulus. Last Friday’s BOJ’s announcement of expanding its already enormous QE program makes it clear that he is adamant about hitting the BOJ’s inflation target.

To grasp the enormity of the program, consider that the BOJ is committing to expand its balance sheet by 17% of GDP annually – equivalent to the Federal Reserve implementing QE1, QE2  and QE3 at the same time. As proven by the Fed’s and BOJ’s QE programs, it can force people into bidding more for riskier assets causing stock prices to surge.

Central Bank Assets  (% of GDP)-3

But what makes Japanese stocks particularly attractive is that they are still reasonably priced. They trade for less than 14x forward earnings and 1.3x book value. The recent depreciation of the yen and the fall in energy prices make it increasingly likely that forward earnings estimates will be reached. And if Abe is successfully able to implement the third arrow of Abenomics, structural reform, then Japanese equities could do even better than I expect.

I decided to buy the $US denominated Nikkei futures trading on the CME because I am concerned about continuing yen weakness and the risk of a Japanese government debt crisis down the road. Japan’s debt load is so enormous that I believe it is already insolvent though it will ironically require the BOJ to successfully create meaningful inflation for the markets to get spooked. In the meantime, I expect Japanese stocks to experience a crack up boom. I will track my trade here.

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