Enjoy it while you can, investors

GRANTED, A LOT ABOUT JAPAN HASN’T CHANGED IN A MONTH.

Since Trump’s election victory, the Japanese stock market has been on a tear. While stateside market-watchers have focused on new records set by the Dow Jones industrial average (up 7.4 per cent post-election) and the S&P 500 (up 5.4 per cent), Japan has been the best-performing major market in the world. The Nikkei 225 ended last week up nearly 17 per cent since Nov. 9, while the broader Topix index is up by 17.2 per cent.

This might come as a surprise to anyone paying attention to Trump on the campaign trail. He hardly made nice with Japan. Among other things, he accused it of unfair trade practices (one of his more anachronistic moments, since trade relations between the two countries have been largely amicable for years) and floated the idea of Japan arming itself with nuclear missiles — a provocative notion, and still an unpopular one, in the land of Hiroshima and Nagasaki.

Given the importance of the U.S. partnership to Japan politically and economically — the States is the No. 1 destination for Japanese exports and foreign direct investment — you might expect that Japanese investors would greet the prospect of a president Trump with something approaching fear and loathing.

For a moment, they did. Because of time differences, Japan’s markets were open during election night, and as the stunning result became clear, the Nikkei 225 shed 5.4 per cent. But the next day, as U.S. indexes rebounded from pre-opening declines, so did Japanese equities, with the Nikkei gaining 6.7 per cent on Nov. 10.

The Trump-Japan rally has been all the more remarkable given how poorly Japanese stocks had performed before the U.S. election. To Nov. 8, the Nikkei had declined nearly seven per cent on the year, as equity outflows rivalled those of 1987, when the Japanese bubble burst. It had been, in large part, a vote of non-confidence in the government’s program of fiscal and monetary stimulus and corporate reforms, dubbed Abenomics, which had failed to do much stimulating.

Since then, though, one very important factor has shifted: the currency landscape. Since late September, the U.S. dollar has strengthened against the yen, but since Trump’s victory it has surged. From Nov. 8, the yen has declined against the greenback by more than nine per cent — very good news for heavily export-oriented Japan.

That relieves, at least for a while, a big problem for the Japanese economy, which had been saddled with a strong currency despite repeated and extreme efforts by policy-makers to weaken it. Against fiscal stimulus from Abe’s government, negative rates and quantitative easing from the Bank of Japan, the yen stayed strong, as inflation and economic growth remained low.

But the rise of the greenback in recent weeks has changed all that — or at least that’s what investors are betting on. The U.S. economy has been turning in robust growth, making the expectation that the Federal Reserve will raise rates next week a near certainty.

Meanwhile, Trump’s potentially reflationary fiscal policies are expected to support further rate hikes from the Fed. And his America First ideas on trade, if he implements them, could further boost the greenback against global currencies.

So in a way, the U.S. electorate (or at least the minority of it that secured Trump a majority in the Electoral College) managed to do in one evening what Abe and the Bank of Japan have been unable to do all year: devalue the yen.

There may yet be some legs in the yen devaluation and the Japanese equity rally. At 115 to the USD, the yen is still off its one-year high of 122 in December 2015, when the Nikkei hit 19,353 — about two per cent higher than it closed last week. Some commentators are seeing the yen at 125 as a near-term possibility.

Granted, a lot about Japan hasn’t changed in a month, and the economy has hardly turned around under Abenomics. Consumer prices fell once again in October, the eighth straight month of decline.

The spectre of deflation still looms. Yet the near-term outlook for Japanese stocks might have less to do with fundamentals than on how long the Trump rally lasts.

If expectations for the U.S. dollar appreciation turn out to be overdone, we can expect the market downturn in Japan to be even more severe than elsewhere. For now, though, investors who have been patiently waiting for a Japanese turnaround might just enjoy the good times while they last.