Retailing, with its huge share price, makes up about 8% of the Nikkei index, a huge position relative to the total size of its company. For comparison, consider that Fast Retailing makes up only 0.3% of the larger Topix index, where allocations are made according to firms’ total market value, not merely the nominal price of their shares. (See chart on the previous page.) It didn’t take long for investors to figure out how to take advantage of the policy. CLSA – one of Asia’s biggest brokerage firms – recommended clients sell shares of auto giant Toyota (7203.T), one of Japan’s best global companies. It replaced Toyota in its recommended portfolio with... Fast Retailing, purely because of its huge weight in the Nikkei 225 index. The broker also recommended Japanese communications giant Softbank (9984.T), which is pursuing a risky, highly leveraged global acquisition strategy. It wasn’t an endorsement of Softbank’s strategy. It was an
endorsement of its nominal share price. You see, after Fast Retailing, Softbank is the second-highest-weighted stock in the Nikkei 225. And sure enough, Softbank’s shares have soared, thanks to the Bank of Japan’s investment scheme. Softbank’s stock was “dead money” due to the collapse of the tech sector until 2012. But once the Bank of Japan ramped up its equity purchases, Softbank’s stock has more than quadrupled, moving from around 2,000 yet to over 9,000 yen. (See chart above.) The decision to use the awesome power of a central bank to invest in the stock market won’t only
hurt investors and “stock jockeys.” THERE IS NO UP, THERE IS NO DOWN Our capital markets are supposed to be “efficient.” That is, modern financial theory explains that by allowing capital to be allocated by the inputs of millions of investors, vast amounts of disparate information can be processed and capital can be allocated where it’s needed most, so it can be used most efficiently. But allocating capital according to nominal share price? And putting the most amount of capital into the stocks with the highest nominal share price? That’s
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