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Last week, Bank of Japan Governor Haruhiko Kuroda, supported by a slim 5-4 board vote, announced a move to cut short-term interest rates to negative -0.1%, effectively charging banks for deposits held with the BOJ. While the knee-jerk response to central bank easing moves is invariably positive, investors should be careful to recognize the context surrounding this move. Based on the broad market action of Nikkei component stocks, market internals in Japan have deteriorated sharply since December, in contrast to most of the period since August 2012. Following a doubling of the Nikkei over that horizon, the current policy shift comes at a time when both valuations and market internals in Japan have shifted to the most unfavorable status in years. 

...What’s somewhat striking is that having moved the Japanese monetary base from 20% of GDP to more than 75% of GDP in recent years, with very little economic response, anyone would seriously call this liquidity “ammunition.” From an economic perspective, the expansion in the BOJ balance sheet has been accompanied by a precisely offsetting collapse in monetary velocity, with little effect on either real GDP or inflation. From a speculative perspective, while the Nikkei Index remains lower than it was in 1986, 30 years ago, investors have demonstrated risk-seeking inclinations in recent years, holding the Nikkei above its 40-week average during most of the period from 2012 until mid-December of last year. 

At present, however, one should take quite a negative signal from the BOJ's action, because it's clearly a response to deteriorating economic prospects. A favorable shift in market internals would be supportive of speculation in Japan, but that possibility should be monitored explicitly. One can’t rule it out, but there is no inherent or reliable tendency for central bank easing to reverse unfavorable market internals, or to avoid steep further market losses (recall 2000-2002 and 2007-2009 in the U.S.).