The Lesson from the Great Rebound of Japanese Stocks in 1992: Starting from the Reversal of Policy Expectations

Key Points

Since 1992, the Japanese government has introduced a series of policies to improve the economy, including capital market support policies, financial system reform bills, to boost market confidence. The stock market subsequently started a rebound trend lasting nearly two years from 1992 to 1994. During this period, the Japanese stock market experienced five waves, with the largest increase reaching 50%. The first two rounds of increases were mainly driven by improved investor sentiment and policy expectations, while the third round was mainly driven by fundamental recovery. Each stage was influenced by various factors such as macroeconomic changes and market sentiment, with different leading sectors.

Summary

Point One: Policy Shift Drives Market Recovery

In 1992, after the Japanese stock market experienced a continuous deep decline following the bursting of the asset bubble, the government began to implement active policies to intervene. It introduced large-scale fiscal policies, monetary policies, price support policies, and financial system reforms to expand public investment, provide liquidity to the market, and prevent systemic risks. The intensive implementation and successful landing of policies boosted market confidence, leading to a significant rebound shortly after the market bottomed out, initiating a sustained upward cycle lasting nearly two years.

Point Two: Fundamental Recovery Drives Market Upsurge

In early 1994, as the macroeconomic fundamentals began to substantially improve, the Japanese stock market ushered in a new round of upsurge driven by the improvement in economic fundamentals. The industrial production index bottomed out and rebounded after a long period of decline, GDP growth turned positive again, and the unemployment rate also declined. At the same time, deflationary pressures eased, the pace of yen appreciation slowed down, further enhancing expectations of economic stability. Positive macroeconomic indicators strengthened investors' confidence in economic recovery, driving the Nikkei 225 index to a new high after a brief pullback since the rebound.

Point Three: Connection between Expectation-Driven and Reality-Driven

During the rebound trend of the Japanese stock market from 1992 to 1994, policy expectations and economic fundamentals complemented each other. Initially, the market rebound was mainly due to the improvement in investor expectations brought about by policy stimuli. Over time, the implementation of policies promoted the recovery of fundamentals, transitioning the market's upward momentum from expectation-driven to reality-driven by economic performance. The mutual confirmation between policy and fundamentals extended the rebound cycle, making the stock market performance more robust.

From Expectation-Driven to Reality-Driven, Five Waves of Japanese Stock Bull Market

In the 1980s, Japan experienced a period of rapid economic growth, with soaring stock and land prices leading to an asset bubble and rampant speculation. Many individuals and companies invested through borrowing, further driving up asset prices. The Bank of Japan subsequently adopted a tight monetary policy, raising interest rates to curb the overheated economy.

On December 29, 1989, the Nikkei 225 index reached its peak at 38,957 points, with investor sentiment also reaching its peak. However, starting from 1990, the stock market began to plummet rapidly as the bubble burst. By 1992, the Nikkei index had fallen to a low of 14,194 points, a drop of over 60% The stock market crash has triggered a chain reaction. Investors suffered heavy losses, and corporate financing capabilities were hit. As asset prices plummeted, the balance sheets of companies and banks continued to deteriorate, leading the economy into a long-term "debt-deflation" dilemma. The stock market crash after the bubble burst became the catalyst for Japan's economic woes, leading to the "Lost Decade" and profound impacts on the entire capital market.

Starting from 1992, the Japanese government introduced a series of policies to improve the economy, boost market confidence, and subsequently led to a nearly two-year rebound in the stock market. From 1992 to 1994, the Japanese stock market experienced five waves, with the largest increase reaching 50%. The first two rounds of increases were mainly driven by improved investor sentiment and policy expectations, while the third round was mainly driven by fundamental recovery.

Policy Shifts Drive the Start of the Market Rally

Starting from 1991, the Bank of Japan began a cycle of interest rate cuts. In the early stages of the bubble burst, the Japanese government had a certain degree of misjudgment about the economic situation, hence the overall cautious policy stance. According to official statements during interest rate adjustments, the Bank of Japan gradually deepened its assessment of the severity of the economic situation.

When the discount rate was first lowered in July, the official assessment indicated that the economic outlook was still relatively high, emphasizing the need to guard against rapid price increases. However, the phrase "high economic level" was no longer mentioned when the discount rate was lowered in November. By 1992, officials gradually realized the "slowing growth in final demand," making the economic recession more apparent. In August 1992, Japan began to introduce a series of easing policies.

The discount rate was lowered from 6% in July 1991 to 2.5% in February 1993, with a total of 6 rate cuts over 17 months. Subsequently, interest rates continued to decrease 3 more times, until it reached 0.5% in September 1995, entering a long period of stable low interest rates.

In order to further stimulate the declining economy, the Japanese government implemented 4 large-scale fiscal policies between 1992 and 1994, aiming to expand public investment, help small and medium-sized enterprises solve their problems, and promote private investment. The total scale of the 4 fiscal policies exceeded 45 trillion yen, with a high proportion allocated to infrastructure projects. The second and fourth fiscal stimulus packages successively set new records since the 1980s.

The bursting of the bubble had significant adverse effects on Japan's capital market and the entire financial system. In addition to monetary and fiscal policies, the government implemented a series of other incremental policies and strengthened regulations through relevant legislation, including Price-Keeping Operation Price Maintenance Operation

In 1992, the Japanese stock market continued to decline, with the Nikkei 225 index falling below 15,000 points in August, a drop of over 60% since the burst of the bubble. To address the ongoing economic stagnation and stock market collapse, the Japanese government, the Bank of Japan, and the stock exchanges jointly launched a Price Maintenance Operation (PKO). Its core objective was to maintain stock prices by purchasing stocks and providing market liquidity to prevent further declines in the stock market.

Financial System Reform Law

In the early 1990s, the bursting of the Japanese bubble economy led to a decline in asset prices, resulting in serious bad debt problems for banks. The accumulation of non-performing loans led to a sharp increase in risks for financial institutions, causing the banking system to be in distress. The financial system was severely hit, with many commercial banks and non-bank financial institutions losing competitiveness in the international market.

To reform the existing financial structure, promote financial liberalization and institutional adjustments, enhance the competitiveness of financial institutions and their stability in dealing with external shocks, increase transparency, and drive comprehensive financial system reform, Japan formulated and implemented the Financial System Reform Law in 1993.

The Financial System Reform Law was the first step taken by Japan to address the financial crisis following the burst of the bubble. Although it did not immediately solve the problem of non-performing loans in the Japanese financial system, it had a positive impact on promoting the modernization of financial markets, fostering market competition, and enhancing transparency. This reform also laid the foundation for a series of subsequent financial system reforms.

How Did Industries Perform in the First Two Rounds of Increases?

A shift in policies led to a significant swing in investor expectations. In August 1992, against the backdrop of the government intensively introducing various policies, market sentiment quickly improved, leading to a rapid and intense uptrend, with the Nikkei 225 index rising by a maximum of 35% in 17 trading days. The policy stimulus resulted in a rapid rise followed by a return to rationality as the market awaited validation of policy improvements and fundamentals, leading to a second wave of pullback.

In the first round of increases, the healthcare sector performed well due to its rigid demand and high prosperity in an aging society. Additionally, investors were highly sensitive to new policies in the early stages of the rebound, benefiting sectors like real estate and finance directly from expanded public investment policies, resulting in significant gains in this round of uptrend. During the first round of declines, investors temporarily withdrew from high elasticity sectors with high uncertainty and shifted to more defensive industries.

Consumer goods and healthcare, due to their rigid demand, were less affected by economic downturns, showing relatively strong resilience. Sectors such as real estate and technology, after a brief period of market heat, experienced declines with relatively high drops Market is also verifying the continuity of policies in a state of uncertainty. In 1993, the government launched the second round of large-scale fiscal stimulus plan, the largest since the 1980s. Various policies gradually landed, strengthening investor confidence. During this round of market trends, the market rose relatively moderately but still reached new highs since the rebound. Due to the lag in the transmission of policies to the economy, the market subsequently peaked and entered a phase of four-wave correction, influenced by factors such as the retreat of market support policies and the sustained weakness in fundamentals.

During the second round of rise, the communication sector rose by over 80%, far outperforming the index average. This was mainly influenced by the rapid development of mobile communication and the internet, as well as the Japanese government's active promotion of communication-related infrastructure construction, making it a hot beta theme.

As a result, the technology sector was favored by investors due to technological development, leading the market. The new round of policies continued to directly benefit the financial and real estate sectors, which still performed prominently in the second round of rise. Basic materials, daily consumer goods, healthcare, and other sectors that resisted the decline in the previous round of correction, due to their limited elasticity and absence of significant undervaluation, lagged behind in the second round of rise. Defensive sectors such as daily consumer goods and public utilities also showed resilience during the index's weakening period.

The technology sector saw smaller declines due to its long-term growth prospects still being optimistic. The financial sector directly benefited from the continued decline in interest rates and the "Financial System Reform Act," remaining strong during the index's correction period. With the increasingly obvious downward trend in land prices, the real estate sector experienced a significant decline in this round of correction. The recession affected the development of the manufacturing and construction industries, leading to a decrease in demand for basic materials, causing this sector to decline significantly.

Fundamental Recovery Drives a New Round of Stock Market Rise

In early 1994, Japan's fundamentals continued to improve, various economic data warmed up, and the stock market experienced a rally driven by fundamental recovery, reaching new highs in this round of rebound.

Overall, the trend of the Japanese stock market leads changes in the economy. In 1989, the stock market and real estate bubble burst, while the industrial production index peaked in 1991, falling for over two years until rebounding in January 1994, entering a continuous 3-year upward cycle, reflecting some economic recovery and validating the effectiveness of policies. The improvement in fundamentals drove the third round of rising trends, reaching the highest point in this rebound cycle.

After experiencing consecutive declines in GDP growth rates and falling below 0, in 1994, Japan's GDP growth rate turned positive, with three consecutive quarters of year-on-year growth, strengthening investor confidence In addition, from 1992 to early 1994, Japan's unemployment rate fluctuated upwards to 3.2%, the highest since 1980. In 1994, the unemployment rate slightly dropped below 2.9%.

After the burst of the bubble in the early 1990s, the year-on-year growth rate of CPI rapidly declined, deflationary pressure intensified, and the Japanese yen appreciated. Between 1990 and 1993, the US dollar against the Japanese yen experienced a maximum decline of over 30%, impacting the export economy and highlighting the risk of tightening. Starting from the second half of 1993, benefiting from continuously loose monetary policies, domestic demand to some extent warmed up, CPI temporarily stabilized and stopped falling, the speed of yen appreciation slowed down, and market concerns about tightening eased. The improvement in inflation data further enhanced investors' expectations of economic recovery, driving the continuation of the stock market's rebound.

Influenced by the wave of information technology such as communication and the internet, in the third round of the rise, technology and communication once again became the market hotspots, becoming the main driving force of this round of rise. Basic materials and manufacturing, due to the significant decline in the second round of correction, underwent valuation repair after the economy warmed up and domestic demand gradually recovered. After the overall market strengthened, there was also a significant rebound.

During the economic recovery cycle, daily consumer goods and public utilities, as weak cyclical sectors, with weak growth momentum, had small increases and significantly lagged behind the index.

Author: Chen Guo (S1440521120006), Yao Haotian, Source: CSC Strategy Chen Guo Team, Original Title: "From Expectation to Reality Driving, Review of Japanese Stocks 92-94 [CITIC Securities Strategy Chen Guo Team]"