Putting the New Japanese Stock Bubble in Perspective

Spotting bubbles is hard but not impossible.

Take a look at this chart of the Nikkei (NIKKEIINDICES: ^NI225  ) , the principal stock index in Japan. As you can see, it shot up by more than 80% in a period of only six months.

It should go without saying that corporate fundamentals had little to do with this trend; it was instead the result of politics. In the middle of last December, Shinzo Abe, president of the Liberal Democratic Party, secured a landslide victory to become Prime Minster. He did so by promising to get the country's economy up and running for the first time since its own massive housing bubble burst in the early 1990s.

Since the election, the Japanese government has set out to make good on Abe's promise. Among other things, its central bank has committed itself to achieving a 2% rate of inflation, driving down the exchange rate of the yen, and implementing a radical program of quantitative easing. But one of the side effects of these policies has been to dramatically inflate the value of equities.

I recently discussed a similar trend that we're seeing here in the United States thanks to the Federal Reserve's third round of quantitative easing. As money flows out of the bond market due to the historical low yields, it flows into stocks. This is one reason, though certainly not the only one, that our own major indexes, the Dow Jones Industrial Average and the S&P 500, have ascended to new highs over the last couple months.

But to get back to Japan, while it's hard to mistake the dramatic nature in the recent stock run-up, it's still worth putting into perspective. If you expand the chart above back to 1984, for instance, this is what you get:

That's what a real bubble looks like.

Are asset prices being distorted by central-bank policies? Absolutely. But it's important to remember that in the absence of robust fiscal stimulus, they are arguably the only thing keeping economies from descending even deeper into the economic abyss.

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