BOJ’s first ETF-free month under Kuroda wins over some investors

Bloomberg

Some investors are cheering the Bank of Japan’s withdrawal from the stock market, even as they brace for more volatility.
Japan’s central bank (BOJ) didn’t buy any exchange-traded funds for an entire month of May, the first time since Governor Haruhiko Kuroda kicked off his easing campaign in 2013. That’s prompting some in the market to believe the BOJ is getting serious in pulling back from such purchases.
Many market watchers are praising the move, saying that the BOJ’s outsized presence — it is the largest holder of Japan equities — has undermined the price discovery process and also become a hindrance to better corporate governance.
“It’s a significant step,” Hiroshi Matsumoto, the head of Japan investment at Pictet Asset Management, said. “The central bank is not a shareholder that has a focus on governance and stewardship codes — and the bigger their holdings grow, the greater the side effects will be.”
The BOJ scrapped its 6 trillion yen ($55 billion) guide for annual purchases of ETFs in March, though it has pledged to step in to the market if sentiment worsens. The central bank also unexpectedly stopped buying funds tracking the Nikkei 225, switching only to those linked to the broader Topix.
Slowing down ETF purchases will help the BOJ set the groundwork for it to eventually curb its ownership of local stocks and allay investor concerns about the longer-term sustainability of its easing program, Christophe Braun, investment director at Capital International Inc, wrote in a note at the end of May.
Last year, the BOJ overtook the Government Pension Investment Fund as the biggest owner of Japanese stocks, with the total value of its holdings climbing well above $400 billion.
It bought a total of 7.14 trillion yen of ETFs last year alone, compared with an average of 4.2 trillion yen every year since 2013.
“Some sections of the investment community have long been lobbying against the BOJ’s purchases of ETFs, claiming the program has distorted the supply and demand dynamics of the Japanese equity market,” Braun wrote. “There are good reasons for the BOJ’s latest policy adjustments.”
Kuroda, however, has said the bank will continue to step in when required.
“Our policy review showed a large scale ETF purchase is effective when market gets very volatile,” Kuroda said in an interview with Bloomberg News on May 27. “We will buy as needed while closely watching the market.”
Last year, the BOJ overtook the Government Pension Investment Fund as the biggest owner of Japanese stocks, with the total value of its holdings climbing well above $400 billion. It bought a total of 7.14 trillion yen of ETFs last year alone, compared with an average of 4.2 trillion yen every year since 2013.
To Hideyuki Ishiguro, a senior strategist at Daiwa Securities Co., the BOJ’s pullback from the market will encourage companies to work to maintain their return on equity over the long term.
“Until now, there was a flaw in the country’s governance reform, with the BOJ purchases supporting share prices and preventing companies from realizing their need for reform,” Ishiguro said by phone. Going forward, “Japanese companies will have to find ways to boost profitability on their own.”
Still, for market bulls, the BOJ’s decision on the pullback was poorly timed, coming as it did when local stocks have already lagged major peers that had more advanced Covid vaccination campaigns.
Both the Nikkei 225 and the broader Topix were whipsawed as worries over higher US inflation and the continued spread of the coronavirus at home spooked investors. Japan is among the smallest gainers this year among 24 developed markets tracked by Bloomberg.
“If the BOJ doesn’t step in, it does make it a bit easier for players to short Japanese equities,” Shusuke Yamada, a strategist at Bank of America, said by phone. “In that sense, the slide in the Nikkei 225 is likely to be deeper than before during times of market correction.”
Over the longer term, however, Yamada says the BOJ’s departure from the market may help lure back investors who had been critical of the price distortions caused by its intervention. Capital International’s Braun says Japan equities look attractive despite a potential overhang from BOJ’s ETF policy change.
The Topix trades at less than 16 times its 12-month forward earnings, compared with the S&P 500’s multiple of over 21 times. Japan stocks look “even more attractive” on a price-to book basis, Braun said, with the Topix trading at about 1.3 times its book value, versus the S&P 500’s 4.6 times and the MSCI Europe index’s 2.1 times.
“The lower valuations could provide a good entry-point for international investors who have yet or are only beginning to refocus their attention towards the country’s stock market,” Braun wrote.