In the future will equities be allowed to fall?

by Shaun Richards

The credit crunch era has seen an enormous expansion of monetary policy activity which has manifested itself in two main ways. We have seen interest-rates cut not only to zero but below it into negative territory. Then we saw enormous expansion of central bank balance sheets as well as Quantitative Easing style policies were added to the play book. Indeed this is continuing apace in both the Euro area and Japan and the latter of course has moved into newer areas as well. Japan Macro Advisers have updated us on the current state of play.

At the end of May 31 2017, the Bank of Japan held a total of 500.8 trillion yen in assets, of which Japanese government securities accounted for 427.2 trillion yen.

I think we have a new candidate for the largest number we have used on here! That sends out its own message but also there is the issue that some 14.7% of the total is not purchases of Japanese government bonds or JGBs. So what might be regarded as conventional QE is already out of date as we note that the Bank of Japan calls its operations Quantitative and Qualitative Easing or QQE.
What is it buying?
You might expect this as after all both the Bank of England has recently and the ECB currently, have ventured into this area.

As for CP and corporate bonds, the Bank will maintain their amounts outstanding at about 2.2 trillion yen and about 3.2 trillion yen, respectively. ( CP is Commercial Paper ).

Whether it does much good is of course another matter as it ossifies economic structures but subsidising larger companies who are able to issue such debt whereas smaller ones cannot. But the main game here is shown below.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual
paces of about 6 trillion yen and about 90 billion yen, respectively.

Here we see intervention in a different sphere as both property and equities are being bought here. The property purchases are relatively small, if you can say that about 90 billion! But the main game in town is the equity purchases.
For comparison here is the plan for what is conventional QE.

With regard to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace — an annual pace of increase in the amount outstanding of its JGB holdings at about 80 trillion yen — aiming to achieve the target level of a long-term interest rate specified by the guideline.

The target level of JGB yields is around 0% for the ten-year.
The Tokyo Whale
Just over a year ago on the 25th of April I alerted readers to what was taking place.

They may not realize it yet, but Japan Inc.’s executives are increasingly working for a shareholder unlike any other: the nation’s money-printing central bank……….It’s now a major owner of more Japanese blue-chips than both BlackRock Inc., the world’s largest money manager, and Vanguard Group, which oversees more than $3 trillion.

That begged more than a few questions as for example shareholders are supposed to hold company directors to account and sometimes provide direction to the business. How can a central bank possibly do that? There is of course the issue of potential losses as well before we get to the creation of a false market.
Let us bring this up to date with thanks to the Nikkei Asian Review.

Japan’s central bank nearly doubles ETF holdings in one year.

With the rate of purchases we looked at above I suppose that is no great surprise but there are genuine questions as to where this is taking us?

The Bank of Japan has stepped up purchases of exchange-traded funds as part of its monetary easing policy, with the balance surging to 15.93 trillion yen ($144 billion) as of March 31.
The total marks an 80% rise from a year earlier and more than a sevenfold increase since the central bank kicked off its quantitative and qualitative easing — adding riskier assets to its balance sheet — in April 2013.

Will stock markets be allowed to fall?
I do not mean on a day to day basis as for example the Nikkei 225 equity index dipped below 20,000 earlier today. But I am starting to wonder about this in terms of sustained corrections. Why? Well take a look at this from the Nikkei Asian Review.

The bank apparently buys frequently on days when the stock market dips in the morning, serving to stabilize share prices.

At what point did central bankers become experts in where share prices should be at? If anybody else did this they would be facing accusations of creating a false market. The point gets reinforced later.

“The BOJ’s ETF purchases help provide resistance to selling pressure against Japanese stocks,” says Rieko Otsuka of the Mizuho Research Institute.

This is quite different to central banks responding to a market collapse and panic in terms of timing,size,scale and indeed intention. There is also the danger of a Buzz Lightyear “To Infinity! And Beyond!” reality as we mull the consequences of this.

The bank’s growing market presence has raised concerns about the repercussions when the easing policy eventually winds down. When speculation of a BOJ exit grows, the anticipated cutbacks on ETF purchases would accelerate selling of Japanese stocks. As a precaution against a sharp market decline, “the BOJ many need to set aside provisions,” Otsuka says.

So that poor battered can has been kicked into the future one more time! If we cannot allow equity market falls now how will we be able to in say 5 years time? This leaves the Bank of Japan sounding rather like Elvis Presley.

Don’t you know I’m caught in a trap?
I can’t walk out

As time goes by the situation will go from bad to worse in terms of market manipulation.

Should the current pace of buying continue, the BOJ’s ETF holdings would reach about 30 trillion yen in about two years. The market capitalization of the Tokyo Stock Exchange’s first-section companies comes to 550 trillion yen.

Also all the jokes and humour about a “Plunge Protection Team” stopping equity market falls move from satire to reality.
Comment
There is much for us to consider here. So far the expansion of central bank activity has not been put into reverse. Even the US Federal Reserve which has nudged interest-rates higher has only talked about reducing its balance sheet as opposed to actually doing it. Others are still chomping away like Pac-Men and Women but the scale of their purchases is increasingly posing problems for government bond markets.
Should the next recession or slow down hit before we see any form of exit strategy then there will be much less scope to buy government bonds. Now that the Bank of Japan has broken the moral barrier around buying equities and indeed property such a scenario would see others follow. If we look at the UK then as the current Bank of England Governor is a “dedicated follower of fashion” he would be likely to join the party.
There are a lot of catches here as we look forwards to a potential future. Equities are supposed to provide a form of price discovery as individuals buy and sell and hopefully there is investing in what are good ideas and people. Central banking bureaucrats are unlikely to add any value here.There attempts so far have fallen on stony ground.

Despite the initial excitement among major financial institutions, the Bank of Japan’s push for exchange-traded funds tracking companies that actively raise employee pay or invest in new equipment has run aground. ( Nikkei Asian Review)

But their loudspeakers should have Yazz on repeat in terms of equity indices..

The only way is up, baby
For you and me now
The only way is up, baby
For you and me now

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