Meddlers Make a Bad Market Worse
You can’t help but wonder if buying more passive funds is actually hurting the market more than helping it.
(Bloomberg Opinion) -- One of the world’s worst stock-market routs just got worse, thanks to meddling central bankers. No, we’re not talking about the U.S.
The coronavirus outbreak has taken Japanese shares to the cleaners. The Topix Index has tumbled close to 30% since late January, as the outbreak accelerated. That’s made Japan an even worse investment destination than neighboring South Korea, which banned short sellers Friday.
The Bank of Japan on Monday doubled its upper limit of exchange-traded fund purchases to 12 trillion yen ($113 billion) per year. As of February, the BOJ had already accumulated a vast ETF portfolio, worth about 32 trillion yen, or 6% of the Tokyo Stock Exchange’s main board.
Despite all that, Japanese stocks are only getting cheaper. The Topix is hovering at a mere 10.9 times forward earnings, a 23% discount to the S&P 500, even after Monday’s plunge. To make matters worse, when BOJ Governor Haruhiko Kuroda assumed office in early 2013, the Topix was trading at a premium to U.S. stocks.
You can’t help but wonder if buying more passive funds is actually hurting the market more than helping it. For one, trust banks, which buy stocks to create ETFs, are free to make those shares available for loans, thereby raising liquidity for short sellers, noted Nicholas Smith, CLSA Ltd.’s Japan strategist, in a recent report.
More importantly, passive buying only exacerbates the defining nature of a stock market. As we’ve observed, ETFs tend to favor large caps. While the U.S. is defined by “big tech” stocks that are highly scalable and rely heavily on end consumers, Japan is dominated by companies that serve other businesses and require hefty investment in factories and equipment. But it’s industrials that get hurt most in this kind of market. Such companies comprise the biggest sector on the Topix, with about a 22% weight.
In a downturn, markets sensitive to global business cycles get pummeled, particularly when investors use them as a proxy for their generally pessimistic worldviews. Unfortunately, Japanese stocks fall squarely into that category. Machinery equipment maker Komatsu Ltd., for instance, lost 36% of its market value this year, despite offering a nice 6.6% dividend yield.
The BOJ must be quite worried about stocks. Before this month, the central bank’s biggest daily ETF purchase was 75 billion yen; on March 2, it bought 101 billion yen — and has repeated that exercise five times since.
Foreigners have already net sold over $15 billion worth of Japanese stocks this year, the latest data from the Ministry of Finance show. This portfolio inflow is highly correlated with forward price-to-earning ratios, a CLSA study finds. In other words, money from abroad chases growth, not value.
The conventional wisdom is not to fight the Fed — or, in this case, the BOJ. While it’s tempting to follow the central bank’s footsteps and hold on to cyclical large caps, we’re starting to see that the coronavirus has changed the global economic landscape. Value stocks are more doomed than ever.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
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