While the Hong Kong markets are still open and busy confirming my technical analysis from yesterday, something else very interesting (that I sadly cannot chart easily) has happened: futures spreads seem to have collapsed in the Hong Kong, China and Japan markets, by nearly half from yesterday on the platforms I watch. I will deal with the implications for Japan here, and get back to China and Hong Kong on my now-daily view of the Shanghai – Hong Kong Stock Connect trading when I have all the data.
In Japan, there are two interesting spreads to look at: that between the Nikkei 225 and its futures chain, and that between the Nikkei 225 and TOPIX. Let’s start with the futures, after the jump!
Nikkei 225 vs. Nikkei 225 December futures:
The futures-spot spread here fell from 15-20 index points down to below 10 over the course of 24 hours! Then, what exactly influences a futures-spot spread? It’s largely influenced by two things: the risk free rate of return (positive influence, easy to model) and the expected dividends on the index (negative influence, difficult to model). The reason is that the futures is the spot price plus the present value of interest that can be gained by not holding the underlying stock but instead lending the money out at the risk-free rate, and futures pay no dividends so increasing dividend payout expectations means that there is less of the forward-looking spot price that the futures represent.
So, which is it? Did Japan start expecting increased dividend payouts from the Nikkei 225, or did they expect lower risk-free returns? Conceptually this is a rather interesting question on a day after more stimulus is discussed, taxes delayed, the central bank board are on the current stimulus path 8-1 (vs. a decision to implement the addition 5-4 in favour on October 31st) and an election is called where there are at least hopes (however dim) that there will be beneficial corporate tax reform. Looking into the details, there are two major reasons why we’re looking at a lower risk-free rate: 1) It’s Japan – if dividends mattered, then Abenomics wouldn’t have brought record corporate cash hoards, or they would have had a lot of impact on spreads after broader adoption of the JPX Nikkei 400 Index by the BOJ and GPIF. 2) The futures contract in question is the next-month future. There simply aren’t a lot of dividends that will be announced in that time!
We can thus conclude that the market looks at inflation as falling even further in the short run and short rates to go lower. This would probably be an expectation that calling the election is not good for inflation prospects, and the uncertainty that this brings is greater than the hope that any new policies for growth and stamping out deflation will take the reins in the Diet. Not a very positive reading at all from the market… I’ll try to give you a little bit better to wash out the taste: onward to the TOPIX/Nikkei 225 spread!
Nikkei 225 futures vs. TOPIX futures:
The spread here is even harder to quantify on intraday data, but it seems as if they are not particularly well matched, so I looked a bit closer at different things it could be correlated to. Previous research shows that the Nikkei 225 is much more correlated to the S&P500 than the USD/JPY exchange rate over long-term periods, reaching up to 5% correlation on 4-year samples (really impressive actually given all the factors that can influence a stock index). This very much seems to be the case on the smaller time periods as well, with the Nikkei 225 futures varying largely over the last 24 hours in tandem with the S&P500, while the TOPIX had a relatively closely following 30-minute average to the Nikkei 225 futures average, but was not nearly as good on minute-to-minute pricing. Near the close of trading, Nikkei 225 futures were down compared to their US closes, while the TOPIX dittos were up a few tens of a percent!
This is probably because the Nikkei 225 samples exporters and large companies to a much larger extent than their representation in the wider economy or the TOPIX. The Nikkei 225 probably has better prospects of producing or selling abroad, meaning that the US markets and dollar value will have a lot more sway on the market, while the TOPIX is largely set to the overall Japanese conditions (including how Japan interacts with the rest of the world).
It looks as if the futures prices in Japan are talking a relatively bitter prose, but the TOPIX is reacting all the sweeter. Contradictory as it might seem on the first level, it probably indicates a failure on political reform. This would mean that there needs to be more monetary stimulus, lowering the risk-free rate, and still allowing corporate earnings to be maintained at a high level. Japan looks to be betting on more Bank of Japan action…