China, Not DPJ Policies, Are Calling the Market Shots     

• Investors fret that the DPJ has promised more than they can deliver. That may well be true, but voter surveys indicate that, while most voted for a regime change, (a) almost half of the voters are resigned to politics as usual, (b) do not think the DPJ's policies are what won them the election, and (c) want the LDP to recover as a force to compete against the DPJ in other words, a true two party system. In other words, voters are waiting to be pleasantly surprised.
• Investors do not appear to have built much DPJ expectations in Japanese stock prices either, as the post-election rally lasted all of a couple of hours before a strong yen and a selloff in the Shanghai composite pulled the Nikkei back down. In fact, the Nikkei one week later was some 417 points lower.
• DPJ spending plans have so far not affected bond yields that much either, as 10-Yr JGB yields are near 2009 lows near 1.25%, versus a peak around 2% in mid-2007. The Yen was already technically poised to rally before the election, which merely gave the yen a little extra push higher.
• In other words, there is little DPJ "euphoria" among both voters and investors.
• People tend to forget that the Koizumi Cabinet also began with a whimper instead of a bang regarding stock prices, which continued to decline for the first two years, while political observers at the time were then in agreement that the Koizumi Administration wouldn't last that long.
• Any lasting impact on stock prices from the DPJ and Hatoyama Administrations will come from deeds, not speculation and/or initial impressions. For the time being at least, China, not DPJ policies, are of bigger concern to Japanese stock prices, as the Nikkei 225 has shown a higher correlation to fluctuations in the Shanghai Composite than the S&P 500.
• Here, our working assumption is that the Chinese government will do what it can to prevent the Shanghai index from crashing before the October 1 anniversary of the People's Republic of China.

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