05/21/14   Sinking 20 Years of Deflation

Editor’s Corner

Ron Rowland

Japan has struggled with two decades of deflation and a lackluster stock market. In 2012, Prime Minister Shinzo Abe came on the scene with promises of an aggressive new monetary policy and huge increases to public spending. Japanese stocks took kindly to the announcements as 2012 came to a close.

The Bank of Japan (BOJ) set forth on a path of quantitative easing and set a 2% inflation target. The BOJ adopted a policy of adding trillions of yen to the monetary base, currently the annual pace is 60-70 trillion yen ($590-$690 billion). The country started to see a consistent positive rate of inflation in mid-2013 and is projecting a rate slightly over 1% for 2014. The stock market followed through on its year-end rally and put in nice gains for 2013.

The first quarter GDP of the U.S. was extremely weak at 0.1%. During the same time, Japan ran away at 5.9%. While that seems like great news for Japan’s struggling economy and a step to end deflation permanently, that gain is seen as fleeting due to another policy measure taking effect. The national sales tax was increased from 5% to 8% on April 1. Analysts are concerned that consumers went all out in the first quarter to avoid the tax increase and that demand the rest of the year will stall badly and force a step backward.

As with Japanese consumers, markets knew the tax hike was coming and that it could be a potential bump in the road. Japan’s stock market is down about 10% for the year, giving back some of the 2013 gains. Looking back at our Edge Charts for the year, Japan has a dubious honor. Using the benchmark of iShares MSCI Japan (EWJ), it is the only one of our 33 categories that has not managed to post a single positive momentum score since January.

The BOJ seemed to take guidance from the Fed’s playbook and hinted several times as the sales tax hike loomed that it believed the economy was strong enough to keep moving forward and no change in policy was needed, but it will keep its options open once the data is tallied. Policymakers also point to a 3.6% jobless rate adding pressure to increase wages, which can help take some of the sting out of the tax increase. Based on stock performance, investors don’t seem to be as confident as the Bank of Japan.

Investor Heat Map: 5/21/14


All of our Sector categories gave up momentum last week.  Those with the biggest drops each gave up one rank to their neighbor.  Real Estate was able to snag the top spot and push Energy down to second.  Telecom moved ahead of Consumer Staples.  Utilities climbed one notch to best Industrials, and Health Care showed Financials the stairs.  On the way, Financials registered a negative momentum score.  Materials remained in 5th, Technology held 8th, and Consumer Discretionary still shows no desire to get out of last place.


For the last two months, Large Cap Value and Mid Cap Value have been taking turns in the top slot, and this week bigger is again better.  There is no reason to read anything into the change as only one point separates them.  Mega Cap wedged its way in between the two and is basically tied with Large Cap Value.  All of the style categories lost momentum, and the value and blend categories had larger magnitude changes than growth.  This paved the way for the week’s last ranking change with Large Cap Growth climbing ahead of Mid Cap Blend.  The bottom five keep the same order.  Mid Cap Growth is now in limbo between red and green.  Small Cap Value was playing that came last week, but it lost to the downside.  Small Cap Blend, Small Cap Growth, and Micro Cap bring up the rear with more double digit negative readings.


Latin America continues its reign as the top-rated international category, but it took a hit to its momentum score this past week and reduced its lead over the number two spot from 16 points to 4.  Emerging Markets was one of only two categories to increase its momentum score, and this allowed it to move up to second place ahead of the U.K.  Canada and Pacific ex-Japan maintained their rankings.  The EU sank two spots, allowing EAFE and World Equity to move up one spot each.  China was the other category that boosted its momentum.  While it wasn’t enough to push it ahead of the U.S. into 9th, it did manage to flip back into the green.  Japan continues to occupy the basement.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“Our quantitative-easing policy is exerting its intended effects. The Bank of Japan will continue with this policy until the 2 percent target is achieved in a sustained manner.”

Bank of Japan governor Haruhiko Kuroda, May 21, 2014


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