Mon, 22 Mar 1999

Japan prepares books for April Fool's Day?

By David DeRosa

NEW YORK (Bloomberg): You can depend on two things in March. Crocuses start to surface and Japanese officials work on patching up the nation's fiscal year-end accounting statements. In the process, ministers and deputies saturate the media with interviews designed to control every market, from stocks to bonds to currencies.

The curious thing this year is Japan actually has some serious investors believing the end of the recession is finally in sight. The benchmark stock index is at a 7 1/2-month high and there's talk international portfolio managers are rebuilding their holdings of Japanese companies.

Practically speaking, Japan has been a portfolio manager's wasteland for almost a decade. So if there are real signs the economy is finally in recovery, a lot of stock buying is going to happen. It may have already started. Some foreign exchange analysts have said the recent drop in dollar-yen is attributable to foreign investors loading up on Japanese stocks.

There's even talk that a massive Nikkei rally is imminent. If international investment managers are determined to rebuild their Japanese equity portfolios, the money flows could be enormous, especially in light of all of the wealth created by the powerful bull market in the U.S.

Clearly things began to change in February when the Bank of Japan started to expand the liquidity base of the economy. Of course this is exactly what everyone -- from ministers of the Group of Seven industrial nations to academic economists -- has been screaming at Japan to do for years. Still, underlying the question of how much longer the stock market rally will continue is the deeper question of whether the rally is real in the first place.

Experienced Japan watchers are suspicious. They say anything good that happens in March is nothing more than a fix. And they're right to think that way.

The most important thing to understand about Japan is that the government sees it as a duty to create accounting success at any expense, even if that includes fiction. They will do and say anything to make markets behave the way they want through the end of March. Then the music stops.

Nothing illustrates this more than the government's shenanigans with the bond market. Going into this year's accounting period, the number one concern of the bureaucrats was to prevent companies from taking a hard knock on their government bond (JGB) holdings. So a campaign was devised to try to push up bond prices.

It worked, at least in part. But just wait until April 1. The key question in the minds of bureaucrats now is whether the Ministry of Finance's Trust Fund Bureau should continue to buy bonds from the secondary market.

Right now, Finance Minister Kiichi Miyazawa indicated he plans to instruct the fund to continue buying after April 1. What a farce! Of course he had to say that. Otherwise the jig would be up. If Miyazawa said bond purchases would stop March 31, the bottom would have fallen out of the market immediately. And it may be true that the Trust Fund Bureau will buy some bonds in April.

Even so, such purchases have to slow down at some point. That's simple to deduce because it's likely Japan is on the verge of a mountain of bond issuance. That is why authorities keep tying to find new pockets of the yield curve, like a 30-year bond, where they can stuff some bonds.

No matter how much the Trust Fund Bureau buys in the secondary market, the sheer size of the new issue calendar will dominate the market.

And that is why I am suspicious of the Nikkei's rally. It looks to me as though the finance ministry got two for the price of one -- by talking up the bond market they got a stock rally. When the music stops for the bond market, stocks won't have a chair to sit on.

All of this presumes that Japan isn't really on the mend in the true economic sense. And even if you thought it were true, you couldn't be sure, at least not in the month of March, because of all the government hype.

If I'm wrong, then I will miss the bottom of the market (which nobody but liars ever get anyway). But if I'm right, I will have dodged a big bullet.

The writer is president of DeRosa Research and Trading and an Adjunct Finance Professor at Yale School of Management. The opinions expressed here are his own and don't necessarily represent the judgment of Bloomberg LP or Bloomberg News.