Japan’s Nikkei Stages Titanic 7.7% Rally, What History Suggests

Stock markets have once again turned into a vicious RISK ON mode.

After yesterday’s 2.4% slump, today, Japan’s Nikkei soared by an astounding 7.7%!

Today’s monster rally has prompted cheerleaders to celebrate and rationalize a "reversal".

From Bloomberg:

Japanese stocks soared, with the Nikkei 225 Stock Average staging the steepest advance since the aftermath of the 2008 Lehman Brothers Holdings Inc. bankruptcy, amid speculation a selloff that drove valuations to an 11-month low was overdone.

The Nikkei 225 jumped 7.7 percent to 18,770.51 at the close in Tokyo, its biggest gain since October 2008, to reverse losses on Tuesday that wiped out the gauge’s 2015 advance. The broader Topix index surged 6.4 percent to 1,507.37, the most since March 2011, amid volume 9 percent above the 30-day average. Japanese shares suffered the world’s second-steepest drop through Tuesday since China’s shock yuan devaluation last month, with Shanghai’s equity gauge the only one that fared worse.

“The selloff in Japanese equities has been excessive amid concerns over China’s economic slowdown,” said Khiem Do, Hong Kong-based head of multi-asset strategy at Baring Asset Management, which oversees about $41 billion “Today’s rally can be sustained once the market’s perception of the Chinese economy improves.”

Like crashes, sharp meltups hardly represent “valuations” but volatility in response to recently vented pressures from accrued imbalances, which the markets are yet trying to distill. There won't be crashes or meltups if markets strictly followed "valuations" in its supposed pricing dynamics. Valuations function as symptoms rather than causes.

Just take a look at the so-called “best days” (above) of the Nikkei 225 which I plotted below

Of the 9 incidences (excluding today’s fantastic rip) only two 1,000+ points rally represented a tailwind for a continuing run-up. That was in 1987 and in 1988. 

For a terse background, Japan’s Nikkei topped in December 29, 1989. This was then followed by a horrific more-than-a-decade long crash.  

The next 6 one day sprints were all bear market bounces!

In sum, all eight giant one day spurts occurred during the Nikkei’s boom-bust cycle with a bias for bear market bounces. Most of them transpired during the climax or during the transition from boom to bust.

While the October 2008’s big move was followed by a 38% rally, it hardly brought a major bullmarket. It was in the late 2012, or four years after, when a resurgence of a quasi bullmarket occurred—mostly due to ABENOMICS. 

As part of the Abenomics program, the Bank of Japan (BoJ) has been mandated to include stocks (ETFs) in her large scale asset purchasing program. In November 2014, Japan’s pension fund, the GPIF, was also enlisted to participate in the asset shift favoring stocks. 

This means that whatever bull market Japanese stocks have recently experienced have been mainly owed to the BoJ and to the GPIF. Or said differently, without the BoJ and GPIF, today's bullmarket may not have existed.

Perhaps even today's blitzkrieg may have been inspired by these institutions.

The point is, today’s run hardly guarantees of a reversal in favor of the bulls.

If today should serve as a tailwind for an upside momentum, then probably like 1987-8 it could mark a near climax for the bullmarket.

Otherwise today’s bounce, like most of the other big moves, can function in the opposite direction—a headwind.

Today's price actions by Japanese stocks exposes on the casino like features or boom bust cycles brought about massive interventions by politicians to use the stock markets as political tools.

And if one goes by the 1988-1997 cycle, the huge volatilities turned out to be inauspicious to investors—but great for speculators who got the timing right and for those who were able to exit before every collapse.