bubble in Japan ?

As you may know the Japanese stock market has more than doubled in the last seven months. Last week The Economist featured the Japanese prime minister on its cover as superman. A couple of days later the New York times published a front page, above-the-fold story on the Japanese economic recovery. During the following two days Nikkei average of Japanese stocks dropped 13%.

A bullish magazine cover story right at the top of a big run-up in stock prices makes one reasonably wonder whether or not the Japanese equity party is over. My answer? Not by a long shot.

From the point of view of contrarian theory the cover of The Economist is not as significant a long-term contrarian indicator as it may appear to be at first glance. Tale a look at the top chart which shows the Nikkei stock average on a monthly basis going back to its all time high (red line) in December 1989. As you can see, despite rhe recent run-up, this average is still trading 60% lower than it was at its 1989 high. As I explained in my book it is very unlikely that a bullish investment crowd will grow to bubble-popping size until the market is at all time highs. So I conclude that the bullish cover actually marks the birth of a bullish investment crowd in the Japanese stock market, not the end of the growth of such a crowd.

I have another reason for doubting that this cover marks any sort of important top in the Nikkei or low in the yen. The Bank of Japan has embarked on a massive quantitative easing program which is scheduled to run for two years. I for one think the BOJ now means business and I expect its purchases of Japanese bonds to continue. But given the BOJ's track record many investors doubt that it will continue its QE program. So I think there is a lot of room on the upside in the Nikkei and on the downside in the yen which will be occupied by the charts as skeptical investors start believing in the BOJ's announced intentions.

It is worth mentioning that QE in Japan is bullish for the US stock market too as it is for the rest of the world's markets. The same can be said for the Fed's QE program. So short term fluctuations aside world stock markets are almost certainly headed higher from current levels.