The Nationalization of Japan's Stock Market

At my old (now closed to the public) blog, I observed last April 2016 that the Bank of Japan's QE, which included buying stock market ETFs had virtually meant the nationalization of its equity markets:

The BoJ's QE program, which has partly been intended to bolster the stock market, implicitly means the use price controls. Such tacit price controls were originally designed to favor stock market owners through the mechanism of increased demand provided by the BoJ and reduced supply from the public in order to push equity prices higher.

Yet increases in BoJ's share ownership of a corporation means decrease in the public's share ownership.  Remember, the BoJ buys these shares from the public. Hence, intensifying implicit price controls through the deepening of BoJ's asset buying extrapolates to the path of complete nationalization of the Japan's stock market.

Furthermore, as the BoJ increases its ownership in the stock market, liquidity is reduced if the BoJ does not sell. Eventually, the greater the BoJs ownership, the lesser the trading volume/liquidity. In essence, sustained BoJ QE would mean monopolization, and thus, the end of the stock market.

A major mainstream research outfit seem to share my view. From CNBC: (bold mine)

In a report titled, "BOJ nationalizing the stock market," Nicholas Smith, an analyst at CLSA, said that the central bank's exchange-traded fund (ETF) buying program was distorting the market.

At its late July meeting, the BOJ said it would increase its ETF purchases so that their amount outstanding will rise at an annual pace of 6 trillion yen ($56.7 billion), from 3.3 trillion yen previously.

Those purchases were particularly distorting to the market because they focused largely on funds tracking the Nikkei 225 index, Smith said in a note dated Sunday, estimating that more than half of the BOJ's ETF buying was likely in Nikkei-tied funds.

That was particularly distorting because that gauge was "a Flintstones index from an abacus age," due to its arbitrary inclusions.

For example, he noted that Uniqlo owner Fast Retailing had the largest weighting in the index, but that was primarily due to its high share price after avoiding any stock splits since April 2002. He estimated that BOJ buying of Nikkei-tied ETFs worked out to more than 16 percent of the stock's free float each year.

By comparison, Toyota Motor had the biggest market capitalization of any Japan stock, but was only ranked 15th by weight in the Nikkei index, he noted.

"If it seems strange that the BOJ is hamstringing the price discovery mechanism of the Japanese stock market by partially nationalizing it, it is all the stranger that it chooses to do so by substantially skewing its buying towards such a distorting index," he said. "The arbitrary decisions of the Nikkei committee get to choose the destination of trillions of yen of BOJ – and hence government - money."

Smith expected that as long as the BOJ continued to buy ETFs, the Japanese market's performance would become increasingly a function of liquidity in the central bank's buying basket.

Other parts of the stock market were also being distorted, analysts said.

The BOJ's purchases of Japan real-estate investment trusts (J-REITs) had also lost market-based "price discovery," analysts at Deutsche Bank said in a note Friday.

They noted that on August 18, the BOJ purchased around 1.2 billion yen worth of J-REITs for a total of around 61.2 billion yen worth so far this year and 330 billion yen worth since October of 2010. Last week's BOJ action caused the TSE REIT index to drop sharply in the morning session then surge later in the afternoon, the report said.

Because the J-REIT market is so small, the BOJ's purchases have an even stronger tendency to distort the market than the central bank's ETF purchases, Deutsche Bank said.

"While real estate majors are trading at more than 30 percent discounts to net asset value, their price levels are exactly opposite those of J-REITs, which are at premiums of above 30 percent," Deutsche Bank said, noting that both sectors should be tied to Japan's real-estate market.

"The elimination of the price discovery function leads to lost buying opportunities for investors and ultimately weakens the investment appetite," the report said, calling it a "serious error" by the BOJ.

Price "distortions" simply means that prices of such securities have veered from reflecting on the underlying fundamentals. Of course, this means that such misalignments signify as unsustainable conditions which will be subject to eventual (most likely violent) market clearing process.