Can Political Change Drive a Japan Rally?     

• The S&P 500's holding of 870 resistance despite a growth scare is further evidence that this is no "sell in May and go away year", as we pointed out in our May 5 market letter.
• Technology stocks have been the leaders so far in 2009, but there is a lot of repair work underway in economically sensitive basic materials and industrials stocks that should pay off in the second half. On the other hand, investors remain severely intolerant of earnings disappointments and balance sheet risk.
• While we remain very concerned about Japan's long-term structural problems, Japan's Nikkei 225 is generally moving with the S&P 500, and moreover has had a close positive correlation with 10-year treasury yields i.e., if US treasury yields continue to rise, so will the Nikkei 225. 
• Thus the blogosphere of late has been painting Japan stocks in a much more positive light even as overseas economist disparage the serious structural problems in Japan's economy.
• One cause for hope is the prospect of the Democratic Party of Japan (DPJ) seizing power from the Liberal Democratic (LDP) for essentially the first time in the postwar period in the upcoming August elections.
• In the past 10 lower house elections, the general tendency of stocks has been downward, particularly directly after the elections. The main exception was 2005, when a "renegade" Junichiro Koizumi energized Japanese voters and foreign investors with promises that he would even destroy the LDP to effect wide-raging reforms and rejuvenation in Japan's economy. In the end, the Koizumi Administration had only limited success, but the initial response of the stock market was to rally 20%.
• We don't see the same kind of enthusiasm for the DPJ, but rather a steeled resolve that nothing will change for the better unless the decrepit LDP is shown the door.
• Moreover, history has shown that election results are not sufficient enough justification to become bullish or bearish on Japanese stocks. If the DPJ after six months is actually getting some positive traction with their economic policies and the change is for the better, we may have something that is actually tradeable.

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