At the interest rate meeting in March, the Bank of Japan announced that it would stop buying stock ETFs. Now the world is paying close attention to how and when the Bank of Japan plans to handle this huge amount of money. This may be the key to determining the future trend of Japanese stocks.

On March 28, the team led by Morgan Stanley analyst Sho Nakazawa pointed out in a report that in the face of unrealized gains and dividend income from Japanese stock ETFs, the Bank of Japan is unlikely to sell its ETFs on a large scale until 2025. The long-term method of selling to the market at a moderate pace may be realistic; it will take about 300 years to sell all of these ETFs to the market.

As part of the monetary easing policy, the Bank of Japan began purchasing Japanese stock ETFs in December 2010. At that time, the Nikkei index was about 10,000 points. As of the end of February 2024, the Bank of Japan held a market value of about 70 trillion yen (474 billion US dollars) last month, which is almost the same as national tax revenue, which is equivalent to holding about 7% of the shares in the Japanese stock market, and has become the largest shareholder.

Morgan Stanley believes that the break-even point of the Bank of Japan holding ETFs is around 1,400 points in the TOPIX index. Currently, the TOPIX index has reached around 2,700 points, which means that ETFs held by the Bank of Japan have unrealized returns of more than 30 trillion yen. At the same time, ETFs will also bring considerable dividend income.

Morgan Stanley believes that there are currently three options for the Bank of Japan to withdraw from the ETF purchase plan: 1) selling directly in the secondary market; 2) setting up an agency funded by the government to buy ETFs held by the central bank; 3) selling directly to families/individuals at a discount, but these measures will take time to avoid having a significant impact on stock prices.

ETFs are a stable source of revenue for the Bank of Japan

Morgan Stanley pointed out that the Bank of Japan decided to stop purchasing ETFs and J-REITs at the March meeting. Currently, the market value of ETFs owned by the central bank is equivalent to 7% of the TOPIX benchmark market, and the rise in the stock market has brought huge surpluses to the central bank's balance sheet. Currently, these ETFs also provide a “stable source of revenue” for the Bank of Japan:

The Bank of Japan holds a large number of ETFs, and the market value of these ETFs has reached 71.0 trillion yen. Currently, ETFs held by the Bank of Japan have unrealized returns of 35.3 trillion yen. ETFs tracking the TOPIX index contributed 21.7 trillion yen, and ETFs tracking the Nikkei 225 index contributed 13.1 trillion yen.

These figures do not include real estate investment trusts (J-REITs) and ETFs that specialize in investing in material and human capital held by the Bank of Japan. If these are taken into account, the scale of unrealized gains is likely to be even greater.

Morgan Stanley believes that if interest rates are raised further in the future, leading to an increase in the interest payment burden, it may have an impact on the Bank of Japan's revenue, and ETF surges can hedge the impact on revenue after the Bank of Japan raises interest rates:

Considering the huge impact of ETF equity management profits on overall revenue, and the possibility that an increase in interest payment burdens due to further interest rate hikes in the future may cause setbacks to bank revenue, we do not expect banks to dispose of their ETFs immediately.

The Bank of Japan may continue to sell ETFs slowly

Dama pointed out that there are various debates and opinions on how the Bank of Japan can withdraw from ETFs. The main types are: (1) transferring ETF holdings to third party entities in order to remove the ETF from the Bank of Japan's balance sheet; (2) long-term sales on the market; and (3) selling to families and citizens at discounted prices (based on cooperation between the government and the Bank of Japan).

Morgan Stanley said bluntly that none of the above three plans will be realized in the short term. The Bank of Japan needs to coordinate with the government and the Ministry of Finance to carefully design the plan to ensure that it will not have a major impact on the stock market:

Some opinions suggest that the Japanese government may suggest transferring some ETFs held by the central bank to individuals to encourage residents to switch from savings to investment. However, this risk will not be the main situation in the short term because: (1) there is uncertainty in the design of the plan; (2) it may have an impact on stock prices; and (3) there may be opposition within the government.

Morgan Stanley believes that if market expectations are mainly based on the Bank of Japan's method of selling ETFs on the market, then the pressure may mainly target stocks with a high shareholding ratio of the Bank of Japan. From the perspective of maintaining the Bank of Japan's financial health and avoiding market disruptions, the long-term method of selling to the market at a moderate pace may be realistic; it will take about 300 years to sell all of these ETFs:

If ETFs owned by the Bank of Japan are sold within 10 years, based on book value, they will exert sell-off pressure on the market by nearly 4 trillion yen each year. What institutions can absorb this sell-off pressure from the Bank of Japan?

Household investments in stocks under the newly launched NISA program may partially absorb this sell-off stream. According to forecasts, households may purchase nearly 10 trillion yen of shares each year through NISA.

Over the past 10 years, the Bank of Japan sold these ETFs at a rate of 1.2 trillion yen per year (at book value). If this speed of sale is simply applied to ETFs currently held by the Bank of Japan (total value 37 trillion yen), then it will take about 300 years (37 trillion yen/year 1.2 trillion yen x 10 years = 308 years) to sell all of these ETFs.

Judging from the situation where the Bank of Japan suspended stock sales during the economic downturn in the past, the ETF sales period may be further extended due to economic conditions, and there is a risk that the sale period may even exceed 300 years.

Editor/Somer