Japan Rejoins Global Markets: Watch US Equities as New NISA Launches

Japan retail has $7 trillion in cash that may be about to be allocated- but to where? Signs point to US equities

Happy 2024 to all - I wish you much alpha and limited drawdowns for the year! Japan markets have been closed in 2024, reopening later today on Jan 4th after its usual longer-than-everyone-else’s New Year holiday.

This year’s Japan re-open start of the year will be especially notable to be cognizant of, and to monitor as Japanese capital rejoins the world - by which I don’t necessarily mean immediately upon 2024’s first Japan market open (though certainly notable - not just for equities, but Japan closed for holiday means that cash trading in US Treasuries during Asia hours has also been closed).

There are two reasons why I’m focused on seeing what Japan equity investors do (or don’t do) to start 2024:

One is for the immediate term global equity market price action, and a potential explanation for the sharp year-end SPX and NDX rally, which occurred for reasons that may very well have little to nothing to do with a suddenly dovish Chair Powell, and the sharp SPX and NDX downside to start 2024 (also which have little to nothing to do with perceptions of Fed policy, now directionally opposite).

The other reason for focusing on Japanese equity investors returning to markets is the launch of a revamped “New NISA” starting Jan 2024 - which is an investment account for Japan residents to invest tax-free up to a certain extended amount - and the potential for massive and sustained flows that may be unleashed into US equity markets, and which may even have implications on the yen.

I. SPX E-minis, NKY futures, and the early-December USDJPY flash crash

Recall this insane day of Dec 7th for the yen, as options-driven JPY futures had seen a major rally and blow-off-top on massive volume, taking USDJPY from above 147 to the 141 handle intraday. Excerpts below:

…that’s USDJPY with a single day trading range from 147 down into the 141 handle, and at one point seeing JPY surging over +2% on $1.4bn notional volume traded within a span of 90 seconds - then whipsawing back down again in a spectacular blow off top.

And THAT is the type of violent volatility can both be caused by, and cause the systematic accounts to trigger automatic liquidations on various other futures positions. For now, it seems that Japan equities were evidently the standout victim.

Though of course it makes sense why, it still is quite unusual to see such isolated behavior among otherwise uniform DM equity indices, particularly in 2023 which had been led by Japan:

Read the full breakdown of JPY listed derivatives activity and price action from Dec 7 here:

https://westonnakamura.substack.com/p/is-the-yen-broken

And here is the JPY futures chart since, which I’ve marked the blow-off top from 12/7.

Now, as per above- I did make these remarks regarding equity market tie-in:

Though of course it makes sense why, it still is quite unusual to see such isolated behavior among otherwise uniform DM equity indices, particularly in 2023 which had been led by Japan:

And included the global equity market snapshot above showing standout downside in one market: Japan, and a sea of green everywhere else. Turns out that I might have been onto something with that comment.

Here is a chart of Japan NKY index futures and NDX100 index futures % performance over the past 3 months, scaled together. And as you can see, Japan NKY and US NDX had been moving percent for percent in lockstep throughout, but then suddenly and widely split apart - with NDX at one point trading a net +8% higher to NKY futures - quite a wide gap:

And what else happened that coincided exactly with this sudden year-end breakout surge in NDX to hit intraday all time highs, as well as an initial sharp opposing DROP in NKY?

That freak rally in JPY futures on Dec 7th:

Now, I don’t know for certain why these markets are behaving the way they are- I just know that they are behaving the way they are. But perhaps my commentary from the Dec 7th JPY flash rally on systematic flows had some insight to it:

…and THAT is the type of violent volatility can both be caused by, and cause the systematic accounts to trigger automatic liquidations on various other futures positions. For now, it seems that Japan equities were evidently the standout victim

Though of course it makes sense why, it still is quite unusual to see such isolated behavior among otherwise uniform DM equity indices, particularly in 2023 which had been led by Japan:.

Read my full article on “Is the Yen Broken?” https://westonnakamura.substack.com/p/is-the-yen-broken

Is it possible that (somehow) systematics were (purposely or not) programmed as a long/short on NDX/NKY futures, which had been triggered to unwind by JPY futures’ hyper volatile rally?

Again, there are no fundamental domino cause-and-effects to try and rationalize NDX / NKY that may or may not even be directly paired as a long/short, nor how a sudden JPY futures rally has to do with this (again, if at all). These end of year thinly traded markets make for systematic futures accounts to have a more outsized influence on price action, and volatility induced, rules based systematic risk position adjustments can occur for any reason, and manifest in any (usually related and liquid futures) market, in any manner.

And this is why I want to see how NKY futures open and trade, and how (if at all) SPX eminis and NDX futures react- which may not come until the US market open with Japan back in the game (if it comes at all).

Meanwhile in the absence of Japan market participants and NKY futures not open for trading over the last 2 days - I’ve noticed this as well-

This “midnight Japan time” JPY futures suddenly getting bid up on volume, and a leg of NDX downside to coincide:

Again- could be nothing, could be intertwined. Either way, I wouldn’t read too deeply into the year end US equity rally, or the year start US equity declines- as they may very well just be functions of systematic (or actively managed) flows, rebalancing and other non-fundamentally related activity. At least not until we get Japan back online, and NKY trading.

II. New NISA Starting Jan. 2024 - Equity Markets Positive, but JPY Negative?

NISA stands for Nippon Individual Savings Account, which is a decade-old program for residents of Japan to invest tax-free (exempt from Japan’s 20% capital gains tax) up to a certain amount per year. This is modeled after the UK’s ISA scheme for those of you who may be familiar. I won’t get into the details of NISA itself - but there are plenty of resources and primers out there for more - Reuters: What is Japan's NISA tax-free investment scheme?

The point is - starting in January 2024, NISA’s revamp (“New NISA”) launches - which expands the annual investment limit to ¥3.6mn (~$25k) per year, as well as the total investment limit to ¥18mn from ¥6mn previous. New NISA also lengthens the tax exemption period on equity investments from previously 5-20 years, to now lifetime tax exemption (within the aforementioned JPY amount limitations).

There has been some talk of the potential for a massive source of consistent and growing equity market capital inflow. FT wrote up a good piece, while I may not agree with all of it, it captures the general message of what’s possible:

FT: Can Japan’s legendary savers spark a stock market boom?

If the ploy works, it will begin to offset an aversion to stocks that has bedded-in since the collapse of the 1980s stock bubble. Japanese households hold just 24 per cent (17 per cent direct and 7 per cent through their pensions) of their assets in equities — far lower than the 54 per cent in the UK and 75 per cent in the US. That sets up, over the coming weeks and months, one of the biggest questions ever asked of the Tokyo stock market, its constituent companies and of Mrs Watanabe. Are savers about to become serious, price-moving retail investors in a domestic Japanese stock market that they have long shunned like a casino? Even a relatively moderate positive answer and a mere 2 per cent reallocation of assets, say analysts at AllianceBernstein, could produce $150bn of inflows into equities. If that happened, it would be market moving, say brokers. Inflows of less than half of that from foreign investors triggered a rally of more than 25 per cent in the Topix this year.

Interesting. Whether or not this deployment of capital ultimately comes to fruition (and even if it does, it can potentially take time- years even) - it’s something that you should at least be aware of.

Also as just an FYI - Japan retail (and Japan institutional for that matter) seem to have an unbreakable bias towards favoring U.S. equities- and the 2023 Japan equity global outperformance showed how unconditional that “market is greener on the SPX side” domestic retail sentiment is- Japan domestics were net sellers into NKY and TOPIX surging to 3 decade highs, with some even saying things like “Berkshire drove up stock prices, but to sell it off to who? Us, the JAPANESE suckers! Long NKY??? No thanks.” …type of rhetoric (seriously, I can’t make that up if I tried). So, if/when Japan deploys bits and pieces of its trillions in mattress-cash into green and red blinking tickers, they unconditionally avoid home base, and go long US, be it Japan outperforming or getting killed.

So with that said, I want to share some charts of what US stock and bond market performance has looked like from the JPY-based investor over the last 1-2 years, as the picture is completely different from what you may think.

Just like how the U.S. has ETFs like SPY and IEF (7-10Y USTs) or TLT (20Y+ UST ETF), those also exist in Japan, listed on JPX, by many different ETF providers including State Street and BlackRock ishares.

They also have these same ETFs which are available as FX hedged versions - much like US listed EWJ (Japan large cap equity ETF), and DXJ (Japan FX hedged ETF).

The ETFs for US assets listed in Japan that have a currency hedge component will more or less behave like the straight U.S. listed USD versions- because the FX hedge attempts to remove currency fluctuations from the underlying ETF holdings’ performance.

So for example (below)- US listed ticker IEF (ishares 10Y UST ETF) and Japan listed ticker 1482 (same ishares 10Y UST ETF + currency hedge) should more or less be the same (net of some slippage and fees). And you can see, both have performed terribly as bonds got killed in the last 2 years.

But notice in the same chart above: Japan ticker 1656 - same ishares 10Y UST ETF, with NO currency hedge- essentially just going long 7-10Y USTs denominated in JPY. That 10Y UST ETF is not only not getting killed, but is positive in its return profile- in fact, ever since USDJPY started to explode higher in March 2022 to current- 1656 10Y UST ETF FX-unhedged has barely even been in the red this whole time. Because- although 10Y USTs have been getting decimated as yields surged, USD had also surged vs JPY, so much so that principal losses were entirely negated by FX gains in favor of the JPY based investor of USD assets.

Now take a look at SPX ETFs in the same comparison:

US ticker SPY, Japan ticker 2634 S&P 500 ETF currency hedged, and 1655 S&P 500 (no hedge).

SPX itself has a bad 2022- but being long SPX from a JPY-based investor never actually saw losses throughout 2022.

And in 2023, when both SPX AND USDJPY rallied, 1655 S&P500 unhedged ETF really killed it, up over 30% on the year. Which beats out even the world’s best performing major DM equity index: home based NKY225.

This reinforces the “go long US” sentiment.

Last one to share- front end USTs. US ticker SHY- 1-3Y UST ETF- terrible performance as Fed rate hikes ripped 2Y yields higher. But the Japan listed equivalent ticker 2620 1-3Y USTs ETF unhedged was up as much as +30% since Fed rate hiking began. +30%! On front end USTs!

And of course, it’s hard not to notice how much the front end of the US curve priced in JPY mirrors that of USDJPY in price action.

So- just wanted to show you what this potentially massive pool of capital has at their disposal under the new NISA - and why US equities and bonds look a hell of a lot more attractive than holding more than 50% of household assets in deteriorating JPY.

Also on NISA…

I will make an offhand comment on NISA’s very existence, and now its vast expansion that’s about to start.

This is basically an open admission by government / acceptance of fact by society that the government’s national pension/social security promise will inevitably be broken, and that everyone is on their own in securing their personal finances for the future, due to inevitable realities of Japan’s enormous debt burden, it’s rapidly aging demographics, and something very obvious but not really ever mentioned alongside “aging demographics + debt” that I will gladly and openly call out: Japan’s hyper-nationalist extreme anti-immigration policies (my fellow Americans, you have no idea what the true meaning of “anti-immigration” by a G7 government looks like - it looks like the world’s 3rd largest economy heavily engaged in international trade and affairs having a purely homogenous population- i.e. Japan).

NISA’s very existence, as well as its current expansion to encourage citizens to proactively become “self-reliant for a prosperous future” does not necessarily mean that the financial state of Japan’s household sector is broken - it is not. As mentioned, Japan’s household balance sheet looks “healthy” relative to its U.S. and E.U. peers - with over half of its ¥2.1 quadrillion (¥2,100 trillion) of household financial assets held in cash (by comparison, European households hold 35% cash, US households hold 12% cash).

Source: Bank of Japan

Over ¥1 quadrillion of cash on the household balance sheet - what’s the problem?

My interpretation of the NISA effort being pushed out to the population is more than Japan’s forewarning to current “younger” taxpaying population (relative “younger” within context of world’s most elderly population- as in people even 50+) that the government will break its future promises and obligations to them. Because if Japan households have a ton of cash in the mattress, why did officials create NISA a decade ago to try and incentivize that cash to be put into risky stock markets, and why the dramatic expansion of NISA on its 10th anniversary (which will not be the last loosening amendment going forward in my view)?

Well, its either one of two reasons:

1) To boost stock markets higher for whatever reason - and which nobody really cares about in Japan like they do in the US - be it Japan officials in government, or Japan corporate executives who, unlike their US counterparts, aren’t compensated with stock options and barely hold any of their own company’s shares, and hence misaligned non-incentives with “shareholder capitalism,” or Japan households who only have 13% allocation to stocks. So, with the exception of the hyper-aggressive levered traders, Japan really doesn’t care what the TOPIX index is doing day to day, week to week, year to year - so the NISA push isn’t to boost corporate equity value. So what else might be behind this concerted push to have household cash convert into long term equity investments, where they would be at risk of principal loss and deterioration of their once cash-rich, “future-ready” household balance sheet?

2) Japan officials are basically saying that in the longer term, holding cash, JPY, is riskier than equities. And nobody is more afraid of equity market risk than post-bubble Japan, and yet they’re still, long term equity allocation is deemed safer than JPY cash concentration.

And again, its not so much about some sunny long term outlook on equities - new NISA allows for foreign single stock buying as well (and as I’ve shown, Japan retail is perma-bull SPX and NDX). So it’s not even about boosting domestic company share prices.

Quite frankly, they don’t care what households do with their cash, so long as they get the hell out of being concentrated long JPY. It’s not (just) about self-sustaining asset growth for individuals so that a broken national pension won’t devastate future generations who paid into it and won’t receive their promised payouts- it’s also about protecting existing net worth while they can, from future worthless assets.

Notice that they also aren’t pushing for cash to reallocate to JGBs/fixed income - and it’s not because they know BOJ has that covered. Maybe it’s because JGBs offer little-no yield anyway? OR - could it be due to the same reason officials are steering households away from JPY cash- avoid Japanese government issued assets, be it JPY or JGBs, as both will someday be massively slashed value, if not outright worthless.

That’s what this whole NISA movement is telling me. Perhaps I’m too cynical. Either way, Japanese households and individuals who currently have the mindset of “I’m too conservative to take market risk- that’s why I’m uninvested and in cash…”

I try to tell these people- unfortunately there is no such thing as being “uninvested” - cash is a position. It’s never ever a good idea to be 100% concentrated into a single asset, be it bitcoin or shares of Berkshire or whatever. But if you’re 100% concentrated long JPY, you just took a net worth hit of -30% in 7 months in 2022, whether you realized it or not.

And I think many are staring to realize JPY cash risk. The government certainly has, hence New NISA starting today - and it will only expand.

I will keep my eyes on NISA uptake from the domestic population, and where the ¥1 quadrillion is being allocated to.

Subscribe to Across the Spread and keep up to date with developments on this front, in the immediate term, as well as over the very long term - as Japan household net cash is the world’s most overlooked source of fresh capital injections into markets that few (if any) are modeling for.

If you found any value in this, please consider becoming a paid subscriber, as we continue to work on building, and roll out the full suite of original content across platforms - your support makes this process possible, let alone expedited.

Thank you for reading, and for your continued support throughout 2024!