Musha Research Commentary

14 August 2024

S\
Strategy
Bulletin (No. 361)

Consider the possibility that the Ueda shock could
be the start of a major bull market
Certain number of people were uncomfortable with the growing optimism in the U.S. andJapanese stock markets since early 2024. The sharp rise in the yen, the plunge inJapanese stocks, and the constant decline in U.S. stocks at the beginning of August
served as a validation of this discomfort.
The discomfort was based on two points: (1) Japan's stock market rally was a bubble
created by the Bank of Japan's mistakenly excessive monetary easing, and (2) the bubble
would deflate if the BOJ stopped its excessive monetary easing policy. However, the Vshaped recovery in stock prices (the Nikkei 225 fell 10,700-yen or25% from the peak but
achieved a half-price reversal in 5 days - on a closing price basis) is revealing that thediscomfort was not correct. The selloff has made Japanese equities even more attractive.
Strong corporate earnings and sharply more attractive stock valuations may provide agood buying opportunity for all investors who are feeling the risk of not owning Japanesestocks (FOMO). We would like to consider the possibility that this plunge could be thespringboard for a stock price rally this fall and into next year.

Why is a major plunge considered to be the beginning of a bull
market?
1) Premature rate hike to be sealed, The Abe-Kuroda risk-taking supportive
policy maintained
The BOJ's hasty rate hike on July 31 and Governor Ueda's hawkish press conference
took people by surprise and caused stock prices to plunge immediately afterward. The
BOJ was reminded of the urgency of conducting market (i.e., stock price) oriented policy
management. On August 7, BOJ Deputy Governor Uchida said, "We will not raise interest
rates when markets are unstable. We can choose the right time (we are not in a behindthe curve situation). We will not deliberately raise interest rates at a dangerous time. We
can only find the neutral interest rate (the interest rate at a neutral level, neither tightening
nor easing) by groping for it, and we can afford to continue seeking it over time," he said.
The comments by Uchida, who is seen as the most influential person within the BOJ,
made it almost certain that the BOJ will continue its supportive Abe-Kuroda risk-taking
path. In the U.S., the "Greenspan put" and "Bernanke put" were frequent examples ofcentral banks easing monetary policy to support the market when the market plunged,
and Japan may be entering such an era.

2) The stock market has begun to function as an umpire of policy
management
The stock market plunge amidst a boom in stock investment due to the NISA program
and the government-led "shift from savings to investment" program caused substantial
losses for New Entry investors. Public criticism of the administration rose dramatically,
and the administration suddenly found it urgent to correct the stock market decline. The
Bank of Japan, the Ministry of Finance, and the Financial Services Agency held an urgent
meeting on the afternoon of June 6, which led to a statement of policy revisions by BOJ
Deputy Governor Uchida. In addition, it is assumed that requests for support of stock
prices from the GPIF and other government-related institutional investors, coordination
with the U.S. authorities, and media manipulation were conducted. This led to a V-shaped
recovery in stock prices from August 6 onward.

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From a historical viewpoint, we may be entering an era in which stock capitalism has finally penetrated Japan andeconomic policies that cause stock prices to fall will no longer be tolerated. The Ministry of Finance and the Bankof Japan, which until now have been able to implement their policies as they wish with the influence on the media
and academia, can no longer defy the newly emerged referee, the market (especially the stock market).
Media, academics, and economists who are in the habit of surmising the intention of Ministry of Finance shouldtake precautions.

Figure1:Stock Price Index in Major countries

700

145

US S&P500
JP Nikkei
DE DAX
CN Shanghai Composite
KR KOSPI

650

140

US

135
130

600
550
500

DE

125
120

US

750

Japan

450
400

110

300

105

250

100

200

95

150

2021

2020

2019

2018

2017

2016

2015

2024

Source: Bloomberg, Musha Research

0

2014

2023

50

2013

1 2 3 4 5 6 7 8 9 10 1112 1 2 3 4 5 6 7 8

China

100

2012

CN

85

Korea

2009

90

Germany

350

2011

KR

2010

115

2025

JP

150

2024

155

850（2009/3/9＝
800100）2023

1/1/2023=100

2022

160

Source: Bloomberg, Musha Research

Figure2:Japanese Interest rates and BoJ Policy

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14 August 2024

3) The worst-case scenario for the U.S. economy (a marked slowdown) has been factored in
The U.S. unemployment rate is rising, stock prices are falling, and the yield on U.S. Treasuries remains below the
short-term yield. However, the unemployment rate of 4.3% in July is still close to full employment, and the increasein the labor participation rate due to the increase in immigration and the hurricanes have had an impact, so theview that the economy is strong prevails. The decline in stock prices from their highs of 6.8% for the SP500 and
5.3% for the NY Dow is also in the realm of cyclical adjustment. A recession is unlikely unless there is a sudden
deterioration in the sentiment of investors, consumers, employers, and other economic actors for various reason.
Two factors that were assumed by the market to cause a deterioration in sentiment were the stock market slump
and financial instability (Black Monday type) caused by Japan's interest rate hikes, but neither was serious (seebelow). The Atlanta Fed's 3QGDPnow is steady at 2.9%. The most closely watched credit risk premium rose lastweekend, but its level is lower than in past crises, and financial market stress has not increased at all (see Figure3). In this context, the stock market's VIX (Volatility Index) and the put-call ratio, a typical short-term bearish
indicator, rose sharply. These market storms, which have no basis in fundamentals, can be viewed as tantrums
associated with excessive deleveraging. If this is the case, the U.S. economy is strong and future U.S. interest
rate cuts will be limited. The adjustment of excessive leverage has already made rapid progress, and the market
turmoil is likely to subside.

Figure3:Credit Risk Premium(BBB-10YtN)

4) The ceiling of the yen's appreciation has also been seen
The yen is unlikely to appreciate very much due to the following four factors. The yen will stabilize within the rangeof 160-145 yen.
First, we do not see much of a narrowing in the Japan-U.S. interest rate differential going forward. If the BOJ is
far from raising interest rates and the U.S. rate cuts are limited, the narrowing of the Japan-U.S. interest rate
differential will be slow. Rather, Japan's long-term interest rates have fallen more than those in the U.S. due toJapan's falling stock prices and the BOJ's sealed interest rate hike. The narrowing of the interest rate differential
has reached a lull. As shown in Figure 4, the narrowing of the interest rate differentials (in all aspects: long-term,
short-term, nominal, and real) has already begun a year ago, and the Japan-U.S. interest rate differential as afactor in determining exchange rates will probably lose its importance.

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Strategy Bulletin vol359

Figure4:JPY/USD rate and US-Japan rate differential
8170Real Longtem
Nominal Longterm
Real Short term
Nominal Short term￥/$ rate

6
4

150

130

2
0

110

-2

90

-4
70

-6
-8
2010/0150
2012/01

2014/01

2016/012018/01

2020/01

2022/012024/01

Source:Bloomberg,Musha research

Second, speculative yen appreciation is also unlikely to continue. The IMM currency futures position on the
Chicago Mercantile Exchange shows that the net short yen position, which had reached a record high of 184,000
contracts at the end of June, shrank to 11,000 contracts on August 9, less than one-tenth of its previous level,
indicating that almost all speculative short yen positions have been eliminated in one month. As shown in Figure
5, net long yen positions have accumulated only during times of financial instability, such as the GFC and Greek
currency crisis (2008-2012), the China Shock (2015-6), and the Corona Shock (2020). If the U.S. economy
becomes firm, there may rather be a situation where short yen positions will be built up again.

Figure5: JPYUSD Rates and IMM Position(non-commercial) 2003～2024
JPY/USD（LHS）

180(Contracts)

100000

160
50000
140
120

0

100
-500008060-100000
Net
（RHS）

40

-150000

20
0-200000
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Source: Bloomberg, Musha Research

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Strategy Bulletin vol359

Figure6: Figure5: JPYUSD Rates and IMM Position(non-commercial) 2020/1～2024/8

0170-20000160-40000-60000150-80000140-100000-120000

130-140000

120-160000

110-180000-200000

100

Third, the contrasting policy mixes of Japan and the U.S. are clearly oriented toward a strong dollar and a weakyen. Based on the economic hypothesis (Mandel-Fleming model) that an expansionary fiscal policy and a tightmonetary policy lead to a strong currency, while an austere fiscal policy and a loose monetary policy lead to a
weak currency, the US has a typical strong currency policy mix and Japan has a typical weak currency policy mix.
The government's tax revenues are inflated by the yen's depreciation and inflation. The government has compiled
estimates that the primary balance will be in surplus in FY2025, a sharp recovery from -5.2% in 2023 (OECD,
November 2023). That means that, viewed in reverse, public finances will depress private demand by 2.6% peryear between 2024 and 2025. While the weak yen's inflation is depriving households of income in the form oflower real incomes, it is also generating huge income transfers to the government. For the Japanese government
to achieve a surplus in the primary balance by stashing away higher tax revenues means that it will maintainintense pressure on the yen to weaken. Stopping the yen's depreciation will require a major reversal of the fiscal
austerity program, and until this is initiated, the yen's weakening trend is not likely to change significantly.

Figure7: Dollar Hedge cost－Rate Differential for JPN and Euro
-3

Dollar Hedge CostーRate Differencial(JPY)

-2.5
-2

H cost > Rate D

-1.5
-1
-0.5
0
0.5
1

H cost < Rate D

1.5

2024

2024

2024

2023

2023

2023

2022

2022

2022

2021

2021

2021

2020

2020

2019

2019

2019

2018

2018

2018

2017

2017

2017

Source:Musha Research

2020

Dollar Hedge costーRate Differencial (EURO)

2

Fourth, the market's view of the yen's future depreciation has remained intact even during the yen's appreciation
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since July. The market's view of a weaker yen can be inferred from foreign exchange hedge costs, which exceed
interest rate differentials, but as shown in Figure 6, the Japanese yen alone has remained sharply higher foralmost two years and has not changed at all. Until the beginning of 2022, the hedging cost of the Japanese yen
against the U.S. dollar was almost the same as that of other currencies such as the euro, in the 0% range, but at
the end of 2022, the cost jumped to almost 5%, and is still at an abnormally high level of 5-6%. Since the cost of
currency hedging has become abnormally high only against the Japanese yen, Japanese investors have been
losing 2 to 2.5% if they hedge their currency exposure and invest in U.S. government bonds for more than two
years. This hedging cost of the yen against the dollar, which exceeds the difference between Japanese and U.S.
interest rates, has risen sharply in accordance with the rapid depreciation of the yen since the early spring of 2022
and has remained 2 to 2.5% above the interest rate differential since then. That can be understood as the market
assuming a 2-2.5% annual depreciation of the yen.

5) Valuations and supply-demand balance for Japanese equities have become more attractive.
There is a favorable wind blowing on the Japanese economy and capital investment in the future. There is aheadwind for consumption in the form of lower real income due to inflation, and a favorable wind brought about
by asset effects. Moderate growth to be sustained.

Pessimism that stirred anxiety at the bottom, Black Monday revisited?
In this sharp decline, speculators who sold off the market by stirring up fears of another Black Monday are believed
to have played a dark role. In response, the usual opinion leaders who loudly asserted pessimism, "The bubble
is about to burst," stirred up anxiety at the bottom.
The crucial difference from the time of Black Monday, the difference in the dollar confidence, is more important
In 1987, the main focus of international cooperation was to rebuild confidence in the dollar, which was weakened
by the twin deficits of the U.S. In February, an internationally coordinated ruble agreement was reached to restore
confidence in the dollar. Fed Chair Greenspan, who had just taken office, was forced to raise interest rates todefend the dollar, but West German interest rate hikes against inflation made U.S. monetary management difficult,and international cooperation was cracked. In this environment, New York stocks had risen sharply in value by
30% from the beginning of the year through August, and a sense of discomfort was growing in the market. This
was the background to Black Monday on October 19, 1987, when the Dow plunged 23% or 508 points in a single
day.
In contrast, this time, confidence in the dollar is sufficiently high and U.S. domestic savings are plentiful, allowing
the Fed to cut interest rates freely without worrying about the dollar's credibility. It is safe to say that there is noelement of international financial instability that would result from a rate hike in Japan. The contrast between
Japan's rate hike and the U.S. rate cut is certainly similar, but this does not mean that the scenario of "Black
Monday coming back" to terrorize the market was reasonable.

Figure8: U.S. financial markets before and after Black Monday
14700Black Monday
1987/10/19

12

600

10

500

10YTN

8
400

6

FF rate
300

4

200

S&P500(r)2

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1995/11/01

1995/06/01

1995/01/01

1994/08/01

1994/03/01

1993/10/01

1993/05/01

1992/12/01

1992/07/01

1992/02/01

1991/09/01

1991/04/01

1990/11/01

1990/06/01

1990/01/01

1989/08/01

1989/03/01

1988/10/01

1988/05/01

1987/12/01

1987/07/01

1987/02/01

1986/09/01

1986/04/01

1985/11/01

1985/06/01

100

1985/01/01

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The theory of the bursting of the "bubble of a weak yen and high stock prices" thatheightened market anxiety
Strategy Bulletin vol359

On the other hand, in Japan, regular Abenomics critics and austerity advocates argued that "Abenomics andKuroda's extreme monetary easing created a bubble with a weak yen and high stock prices, but the time hascome for judgment. Economist A said, "There may be a strong aspect of the collapse of the bubble of a weak yen
and high stock prices created by the Bank of Japan. ・・・・ believes that the collapse of the "bubble of a weak
yen and high stock prices" created by the Bank of Japan's unprecedented monetary easing, which was maintainedeven amid soaring global prices, is behind the collapse.
Professor B also said, "The global stock market has had three "extra bubbles" since the Corona shock, whichshould have resulted in the complete collapse of the bubble. There was the "bonus bubble No. 1," the Corona
subsidy bubble, the "bonus bubble No. 2," the monetary policy put option bubble, in which the FED to cut interest
rates. The "bonus bubble No. 3" is the AI and semiconductor bubbles, or the "Magnificent 7” In other words, three
encores of the bubble, in response to investors demanding "another round of bubbles." He asserted.
Furthermore, Chair C said, "The market is now in the final stage of an abnormal money glut, and stock prices
could burst at any time. There will be a big crash soon. The new NISA started at such a time, further igniting theoverheated market. and other such arguments.
We respect these courageous objections, but in the unlikely event that the hypothesis is incorrect, we would liketo see a frank correction of logic.

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