Indexing Rattles Japan Stock Market

April 01, 2000

Japan emitted a signal in April that the indexing of major portfolios is not only a major factor in US markets but is becoming a market factor to be reckoned with elsewhere in the world.

Much of the action became apparent on Friday, April 21, the last trading day before the first major rebalancing since 1991 of the bellwether Nikkei 225 officially took effect. Portfolios benchmarked to the Nikkei dumped the 30 stocks being removed - old-line names like Mitsui Mining, Fuji Spinning and Nippon Carbide. But they dumped a lot more besides - big-name, high-liquidity stocks like Sony and Takeda Chemical Industries also took a hit.

According to a tally reported by The New York Times, the names being deleted had a combined market capitalization that totalled about 6% of the old Nikkei, but their replacements had a total market cap equivalent to 42% in the new Nikkei. Indexers had to raise enough money - by these numbers, about 36% of their total indexed portfolios - to be able to rebalance their portfolios to match the new list. That forced widespread selling of other names in the index, whose percentage share of the Index's market cap was also reduced by the advent of the big newcomers.

In dollar terms, one market observer calculated Japan's indexers would have to sell a net $6.5 billion, implying portfolios totalling some $18 billion might be affected and forced to move in a relatively short space of time.

While this selling and buying were doubtless spread across several weeks, April 21 was the likely peak date for such changes. On that date, the Nikkei fell 706.64 points, or 3.7%, the day after the Dow Jones Industrial Average in the US rallied 169 points. Over a period of about five weeks, the old names had fall en an average 29%, while the new names had risen 11%, even as markets worldwide were being rattled by violent fluctuations in the US markets.

The New York Times also noted that there were hundreds of billions of dollars worth of derivatives based on the Nikkei, and there was no telling what the impact of revaluing them might be. But most of the contracts would have assumed an historically typical 20% annual volatility in the Nikkei and would now be confronted with volatility of at least 30% and perhaps considerably more. While buyers might find the value of their contracts had effectively doubled, sellers - typically Japan's beleaguered banks and securities firms -would suddenly see a large increase in their liabilities.

This coming of age in Japan was presaged last year when the introduction of indexes for that country's over-the-counter market touched off a burst of buying in the new indexes' components (see Indexes, Jan.-Mar. 2000). Now indexers have visibly shaken Japan's most important stock market benchmark. Nihon Keizai Shimbun, Japan's biggest business newspaper and the publisher of the Nikkei 225, says it will hereafter rebalance its index annually.


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