Japan’s market takes a tumble

New Year opening ceremony at the Tokyo Stock Exchange Image copyright Reuters
Image caption The Nikkei has jumped by more than 40% in 2013

If you invested in the Japanese stock market at the start of the year, you would be 40% richer.

You're probably thinking about whether it's time to take your money out. Seeing some worrying signs in the US and China might help make up your mind.

As the decline was broad and across all sectors - ranging from financials to manufacturers - it looks like a broad sell-off of stocks for investors to realise some gains.

That's what is called profit-taking.

Japan's stock market fell by about 7% which is the steepest decline since the tsunami and subsequent nuclear disaster of March 2011.

But the market is still up by more than 30% since the start of the year.

So those selling still made a tidy profit.

Those worrying signs

The strong growth of the Japanese equity market, and other markets, looks inconsistent as compared with the underlying weakness of major economies including the US, Germany and the UK. (See my earlier post). Cheap money from central banks has played a part, since stocks can be bought using borrowed money.

So, when Fed chairman Ben Bernanke said its cash injections may slow in the next few months if employment improves, it affects market sentiment. This was compounded by the minutes from the last Fed meeting where other members expressed a similar view.

Even though this isn't surprising - the Fed had said it would inject $85bn in cash each month until the unemployment rate fell to 6.5% and inflation wasn't too far off its 2% target - a stir has been caused by a sign that this point may be reached sooner than expected.

Plus, Japanese companies rely on export markets, especially that of its largest trade partner, China.

And today an influential survey, the PMI indicator conducted by HSBC, suggested that Chinese manufacturing has contracted in May. The preliminary reading was 49.6, the first estimate below 50 in seven months. The market as seen in consensus forecasts hadn't expected it.

They thought manufacturing expansion would slow to 50.4 but not contract. Negative surprises don't usually help sentiment.

Considering that in April that same PMI measure indicated a slowing from the first three months - when growth dropped to its lowest in 13 years since the Asian financial crisis - it was another worrying sign for the world's second largest economy.

Not just stocks

Other assets like bonds also declined. The yield, or interest rate, on 10 year Japanese government bonds hit 1% for the first time in a year, but then fell below that level again. As the yield is inversely related to the price of the bond, that means that the bond market fell as well.

The movement was so large that the Bank of Japan intervened to stabilise the market by injecting 2 trillion yen.

This could be part of the movement out of riskier assets, as there is a lot of Japanese government debt. Of course, the Japanese central bank is buying bonds to inject cash to reflate the economy.

But if so-called Abenomics, the large-scale cash injection and fiscal stimulus programme of prime minister Shinzo Abe, works and defeats deflation then prices would begin to rise and that would mean higher interest rates in the future. Or, actually a more normal interest rate because borrowing for 10 years at less than 1% is rather extraordinary.

Key signs

An important sign as to whether Abenomics is working and conditions are beginning to return to normal will be wages.

If firms are doing better, then they will pay higher wages. Higher wages will support price rises, so Japan can return to normal levels of inflation.

If that were to happen, then bond and stock markets would also begin to look a bit more normal.

For the rest of the world, stock markets may also begin to level off if money ceases to be so cheap. But, that could signal an improvement in the economy, which is ultimately what we would all like to see.