A Rally of Smoke and Mirrors?

Is the Nikkei's 12-year death march finally over? Japan's key stock index shot up nearly 6% on Mar. 4 and is now trading at seven-month highs, following big gains on Wall Street amid hopes that a full-fledged recovery is under way stateside. A big bounceback in the U.S. would certainly lift Japan's export sector, which accounts for 10% of gross domestic product.

But is the Nikkei's rally really signaling a broad recovery in Japan? Dream on. This bull market has an artificial, engineered feel to it. For starters, the government has just imposed tougher compliance measures and higher margin requirements on the short-selling of Japanese equities. As much as a quarter of trades in recent months have been short sales and margin sales. But the crackdown--justified or not--has sent the shorts scurrying for cover.

Dampening short trades, naturally, has removed some downward pressure on the Nikkei. The market is getting other quick pick-me-ups. Bank stocks have rebounded thanks to talk of another round of government capital injections--but that's hardly a long-term bullish indicator.

There is also evidence that the big Japanese trust banks, which manage pension funds, have been encouraged by the government to buy stocks and goose the Nikkei before the end of March, when the fiscal year ends. That will help commercial banks avoid big valuation losses on their stock portfolios, losses they would have to report on Mar. 31. Can't let that happen.

Of course, the biggest reason to be skeptical of this Nikkei rally is that the economy stinks. Japan's deep deflation, lousy corporate earnings, and anemic consumer spending outweigh the brighter outlook on exports. On Mar. 10, the government is expected to report that fourth-quarter gross domestic product fell 3% to 4% on an annual basis. HSBC Holdings PLC (HBC ) senior economist Peter Morgan says, as a result, he will probably lower his 2002 forecast from negative 1.1% to negative 1.5%.

Some rally.

By Brian Bremner in Tokyo

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