LHV Pensionifond S

The world’s largest stock markets have continued the upward trend that began last October, undergoing a new period of acceleration and reaching new peaks. In my opinion, however, the biggest event in the global stock markets was the powerful rise of the Nikkei 225 index, which tracks the Japanese stock markets.

A 34-year journey back to the old peak

On 22 February, the value of the Nikkei 225 index rose by 2.2% to 39,098.68 points. This surpassed the previous record of 38,915.87 points set on 29 December 1989, which had stood for 34 years. At that time, the record was achieved when the Japanese economy was at the peak of the post-World War II boom, while the new record followed two consecutive quarters of economic decline. Although the Japanese economy grew by 1.9% last year overall, the year-on-year economic decline was 2.9% in the third quarter and 0.4% in the fourth.

The Bank of Japan was one of the first to experiment with very low interest rate policies and quantitative easing (QE) or bond buying, known colloquially as money printing. As recently as late February, Japan’s short-term interest rates were negative and long-term bond rates were close to the 0% level controlled by the central bank.

Although inflation has been a source of social tension in Japan for some time, the Bank of Japan has been the slowest among developed countries to adjust its monetary policy. One probable reason for this is the fact that over the years the Bank of Japan has bought a total of about 60% of the central government bonds currently “on the market” and an estimated 7% of the value of the stock market. Understandably, it is very difficult to give up such positions – indeed, doing so requires at least as much creativity as the money printing and the negative interest rate policy.

The debt burden is growing faster than the economy

When interest rates rise, bond prices fall and government budgets come under pressure as interest expenses rise. The graph shows that the US state budget has the largest deficit among the great powers of the developed world. It is noteworthy in this context that the interest rates of ten-year government bonds are 4.2% in the USA, 2.3% in Germany and 0.7% in Japan.

Figure. Budget deficit in the eurozone, US and Japan (% of GDP). Source: Société Générale.

At the same time, the average interest expenditure on outstanding bonds is much lower. This is why the interest expenditure of the Japanese government is only 0.1% of GDP, even though Japan’s national debt relative to the economy is larger than that of the US (the US government’s interest expenditure is 4.5% of GDP).

The debt burden has increased faster than the economy in both the public and private sectors for decades. The growing debt burden has inflated the economy while adding fragility and risk to the economic environment. Economic inequality has been on the rise since the financial crisis of 2008, and the increase in inflation rates over the past few years is once again hitting the weakest members of society the hardest. Therefore, it seems fair to predict that the role of fiscal policy will increase compared to monetary policy. In all likelihood, this means that the central banks’ fight against inflation may become more difficult and less effective.

As Warren Buffett once said: “Price is what you pay. Value is what you get.” This is a principle we have always followed when investing pension assets at LHV.

I recently read an article that pondered whether markets move toward an equilibrium point and overreact occasionally or whether they move toward extreme greed and then extreme fear, and an equilibrium point like the ones shown in supply-demand graphs has hardly any gravitational pull, at least in the short term.

It seems to me that stock markets are currently euphoric because the US, being the world’s largest economy, managed to avoid recession last year. However, this does not automatically mean that the economic environment in the US and elsewhere in the world will be cloudless in 2024. Investors’ risk appetite has increased significantly in the past few months, while the value received by buying stock indices has not changed much.