Nikkei/Topix difference matters more now

As long as the music is playing, the former Citigroup chief executive Charles “Chuck’’ Prince so memorably recommended in 2007, you’ve got to get up and dance.

The problem with Tokyo stocks in 2016 is that the music is still blaring but it is becoming increasingly hard to dance to, sounding like a mash-up of Money, Money, Money, the Internationale and I fought the law played by the Bank of Japan.

The underlying theme, defined by the central bank’s ¥9tn buying of exchange traded funds in the Abenomics years since 2012, has always been unusual: day-to-day trading anomalies are becoming more frequent, brokers seem less abashed about labelling this a “nationalisation of the stock market” and, a couple of months ago, Japanese asset managers endured the pantomime of designing implausible new ETFs primarily to be bought by the BoJ.

But since July 29, when the BoJ announced it would nearly double annual ETF purchases to ¥6tn, the weirdness has become more striking.

The clearest measure of this has been the Nikkei/Topix ratio — a gauge that compares the performance of Japan’s two main stock benchmarks and has just seen the Nikkei’s outperformance of the Topix blast out to an all-time high.

It matters because of the distinct ways in which these two are constructed, the stark differences in each one’s sector weightings, and that the BoJ, for technical and liquidity reasons, is buying about 30 per cent more ETFs based on the Nikkei than on the Topix.

The Topix is a broad market-cap based index, while the Nikkei, described by CLSA’s strategist Nicholas Smith as “a Flintstones index from an abacus age”, is an average of just 225 share prices — unadjusted for free float, its membership determined opaquely and giving a handful of stocks wildly outsized weightings.

This difference did not matter so much in the past, but does with the BoJ on target to own, indirectly, roughly 5 per cent of the market by next year.

Hedge funds on the hunt for mispricing may relish the cacophony of distortion: everyone else may look for something more melodious.