Archive | Macro

What’s Next for the Yen and Japanese Stocks?

By Charles Lewis Sizemore, CFA on April 5, 2013 in Investing, Macro

When it comes to quantitative easing, Fed Chairman Ben Bernanke is playing AA minor league ball at best. If he ever wants to make the big leagues, he needs to take batting practice with Japan’s new central bank governor, Haruhiko Kuroda.

In addition to the “usual” quantitative easing actions of buying government bonds, the Bank of Japan will be buying 30 billion yen of Japanese real estate investment trusts and a trillion yen of exchange traded funds…annually!

By Forbes estimates, the new expansion in Japan’s monetary base amounts to 10% of Japan’s GDP. By comparison, Bernanke’s QE Infinity is less than 7% of U.S. GDP.

Not surprisingly, Japanese stocks surged on the news. We talk about the Fed “propping up” the stock market here (and conspiracy theorists have long accused the “Plunge Protection Team” of manipulating the markets), but we’ve never had the Fed directly jumping into the stock market like this.

What does this mean for Japanese stocks going forward? Or the yen?

Figure 1: USDJPY

The standard “don’t fight the Fed” advice applies here, at least in the short term. The Bank of Japan is determined to push the value of the yen down to boost exports and to shake the economy out of its long deflationary funk. It’s much easier for a central bank to destroy the value of its currency when it is expensive than to prop up its value when it is falling.

So, don’t try to be a hero here by betting against the Bank of Japan. Remember, George Soros made his legendary “bankrupt the Bank of England” trade by shorting the pound when the BoE was trying to prop it up. Not even Soros the Great and Powerful could have succeeded in a long bet against a central bank this determined to weaken its currency.

Let’s take a look at how the yen has performed of late (Figure 1). You have to view this graph in reverse; a rising line means a falling yen relative to the dollar. (Think of it like this; back in November, a dollar would have bought you 80 yen; that same dollar today will buy you 96 yen.)

The yen has been in virtual free fall since it became obvious that Prime Minister Shinzo Abe would win last year’s election, though the yen rose sharply for most of March due in large part to the turmoil coming out of Europe.

Perversely, given Japan’s debt load, the yen became a “haven” currency following the unwinding of the carry trade in 2008 (which should put the nail in the coffin of any ideas you might have had about markets being rational). So, if Europe has another destabilizing wave of volatility, then the yen might enjoy a brief respite. But overall, the yen’s downward trend will likely continue for a while.

Figure 2: iShares MSCI Japan ETF (NYSE:EWJ)

What about Japanese equities?

Japanese stocks, measured by the iShares MSCI Japan ETF (NYSE:$EWJ), have been on a tear since mid-November (Figure 2), coinciding with the yen’s decline. And over the next, say, three to six months, I expect this trend to continue.

But be careful here; Japanese stocks should be viewed as a short-term trade, and most definitely not a long-term investment. In the not-too-distant future, I expect Japan to bust apart at the seams. If the Bank of Japan is successful in reigniting inflation, Japanese bond yields will rise. And when Japan’s financing costs rise, that gargantuan pile of debt (currently 220% of GDP) becomes a lot harder to service.

As I wrote in February, “debt service now accounts for 43% of Japanese government revenues and quarter of all spending. Furthermore, more than half of all Japanese government spending is financed by new borrowing. This means that half of every yen borrowed is used to service existing debts. It’s a debtor’s nightmare that gets worse every year with budget deficits that are consistently higher than 7% of GDP.”

The bond vigilantes will eventually wake up and take note of these sobering statistics, and when they do things are likely to deteriorate very quickly. Think banana republic levels of hyperinflation followed by outright default.

Amazingly, Japanese yields continue to fall for now. The 10-year Japanese bond now yields an almost unbelievable 0.45%. At these levels, shorting Japanese bonds becomes an almost risk-free proposition.

When yields finally begin to rise, get ready for the short opportunity of a lifetime in virtually all Japanese assets. In the meantime, keep an eye on the 10-year yield. When it rises above the 1.0-1.5% level, I expect doomsday to follow shortly thereafter.

Disclaimer: Charles Sizemore currently has no positions in any security mentioned.

Comments { 5 }

Japan is the Next Shoe to Drop

By Charles Lewis Sizemore, CFA on November 21, 2012 in Investing, Macro

The fiscal cliff has been getting most of the media attention these days. And when not fretting over U.S. political gridlock, investors have turned their attention to Europe.

But the real crisis brewing—and the one that no one seems to notice—is in Japan. The land of the rising sun is a ticking time bomb, and when it finally blows up it will make all the talk of Eurozone disintegration seem petty by comparison.

Japan is the most heavily-indebted nation in the world with government debts of over 220% of GDP and a gaping budget deficit of nearly 10% of GDP.

To put that in perspective, Greece, Spain and Italy—the European countries most viewed as being at risk of default—have debts equivalent to 160%, 68% and 120% of their respective GDPs. The United States recently tripped over the 100% mark, but for all of the (completely justified) fretting about out-of-control debt in America, Japan’s debts are more than twice as big.

Once the statistics are released, we will most likely get confirmation that Japan spent a good part of 2012 in recession. And already, the Japanese government is planning a 1 trillion yen ($12.3 billion) stimulus package to jolt the economy back into growth.

Seriously? Japan has racked up the biggest debts in modern history trying to stimulate a dead economy, yet it has still been in and out of recession for the better part of the past two decades. It’s hard to see that extra trillion yen making much of a difference at this point.

I know, I know. Japan is different. Unlike America and Europe, most of its debts are held by its own population, so there is little risk of international bond vigilantes punishing the country the same way they’ve punished Europe’s problem children. Plus, you know the Japanese. They are conservative and save a high percentage of their income.

If your money manager or financial advisor has told you this, pick up the phone right now and fire him.

I say this in complete seriousness. Anyone who says something that phenomenally stupid should not be allowed to manage money professionally. Yet there appear to be plenty of them out there, because the Japanese yen has been pushed sharply higher in recent years by investors who are delusional enough to consider the country a safe haven.

Think I’m being too harsh?

Let’s look at some very simple demographic math. Those high savings rates we all heard so much about last decade were a product of Japan’s high-income earners in their 40s, 50s and early 60s socking away money for a retirement they knew was quickly approaching.

Well, it came. Japan is the oldest country in the world with the highest percentage of its population beyond retirement age (roughly a quarter of the population). And as Japan’s Post-WWII generation drops out of the workforce, they are starting to dip into those savings they spent the last three decades accumulating. Japan’s savings rate is now just 2% and falling—a far cry from the 44% savings rate it recorded in 1990. If it has not dipped into negative territory already, rest assured that it will soon. (The OECD estimates that Japan’s savings rate will be 1.9% next year; that may prove to be far too optimisitic.)

Figure 1: Japan Household Savings Rate (2012 and 2013 Forecasted)

2006	2007	2008	2009	2010	2011	2012	2013
1.1	0.9	0.4	2.4	2.1	2.9	1.9	1.9

Source: OECD

The legions of Mrs. Watanabes that Japan has depended on to buy its government debt are no longer saving and investing. They are living off of their past savings and, given how low interest rates are, are probably going to be selling a good chunk of those bonds in the years ahead to make ends meet.

What then? What do you expect will happen to Japanese government yields when the Japanese have to turn to the international bond markets for the first time?

They could turn to the Bank of Japan, of course. And in fact, that is exactly what Shinzo Abe, the probable winner of Japan’s December election, is advocating. Abe has called for “unlimited” bond buying, and not just in the secondary markets. He wants the Bank to lend money to the government directly.

We have the pieces in place for a hyperinflationary meltdown. This may sound impossible given that Japan has had on again / off again deflation for the past two decades, but it is hard to see any other outcome. As Japan’s borrowing costs inevitably rise, it will have to fund more and more of its budget via the central bank. And from that point, the path to hyperinflation becomes a slippery slope.

Investors will eventually lose their faith in the Japanese yen. It is a little shocking to me that they haven’t already. And when they do, the value of the yen will plummet and the prices that Japan pays for imported products and materials will soar…and will necessitate more money printing.

In Endgame, John Mauldin called Japan a “bug in search of a windshield,” and it’s an apt metaphor. It’s just a question of when it will splat and what the particular windshield will be.

For now, it’s a waiting game. When investor sentiment finally turns on Japan, I see it creating an incredible short opportunity in Japanese assets. If you missed the opportunity in 2008 to short subprime lenders and banks, fear not. You’ll almost certainly be able to make a bundle shorting the yen, Japanese bonds, and Japanese stocks.

In the meantime, keep an eye on Japanese interest rates. When you see them starting to rise, you might want to start setting yourself up for the short opportunity of a lifetime.

SUBSCRIBE to Sizemore Insights via e-mail today.

Comments { 18 }

Europe Will Be the Best-Performing Market for the Rest of 2012

By Charles Lewis Sizemore, CFA on September 26, 2012 in Macro

September 18, 2012 was a noteworthy day for students of history.

King Juan Carlos of Spain stepped into the political fray for the first time in more than 30 years, calling on all Spaniards to stick together during the hard times in front of them and to avoid chasing unrealistic pipedreams (those who can read Spanish can view his letter here).

Advising Spaniards not to tilt at windmills since 1975.

The King’s comments were his most direct involvement in Spanish politics since he intervened in 1981 to prevent a mad, machine-gun-toting colonel from taking over the government.

Today, no one is walking into Spain’s parliament building and spraying the ceiling with bullets, but the King’s letter is telling. Spain—and much of the rest of peripheral Europe—is mired in a cycle of debt-necessitated austerity and economic contraction that has created the worst crisis in decades. Europe is a mess.

For all of the optimism surrounding Mario Draghi’s “Big Bazooka” moves to stabilize the Eurozone through outright monetary transactions, the crisis still has a long way to go before it is resolved.

And I should be clear—it may never get resolved.

Depending on the political decisions made over the next 3 – 6 months, the Eurozone could emerge from the crisis as a stronger, more durable union. Or, the entire European project—which has been in the works for sixty years now—could come apart at the seams.

With all of this as an intro, you might be surprised by what I say next: I’m bullish on European equities and maintain an overweight position in them in most of my client portfolios.

Let’s look at some of the bullish arguments:

The ECB doing “whatever it takes” via unprecedented monetary stimulus – All investors have heard the standard advice: Don’t fight the Fed. I would argue that, for the first time, the same can be said of the European Central Bank. Mario Draghi broke long-standing taboos and asserted his authority over the German Bundesbank by launching his program of potentially unlimited outright monetary transactions over the objection of Bundesbank President Jens Weidmann. Draghi has a bigger bankroll than you, and he’s shown that he’s not afraid to use it, even if it means stretching his constitutional mandate. This does not by any means suggest that Draghi can create the conditions for a durable bull market; but it does mean that he can stoke the flames of a multi-month rally.
The bailout mechanisms will clear up the uncertainty weighing on the market – Spain has yet to formally request aid from the ECB or the bailout institutions; yet rumors that prime minster Mariano Rajoy was getting close to doing so was enough to send Spanish stock prices soaring last week. According to leaked news from the parties involved, EU and Spanish officials are working behind the scenes to set out the conditions for a Spanish bailout that Rajoy would accept. Meanwhile, Der Spiegel reports that talks are underway to allow the Eurozone’s primary bailout fund—the European Stability Mechanism—to be leveraged to 2 trillion Euros if need be. Suffice it to say, a lot of monetary firepower is being thrown at the Eurozone, and a fair bit of it can be expected to find its way into the Eurozone equity markets.
European stocks are the cheapest in the world – Finally—and most importantly—European stocks are dirt cheap relative to their world peers. To be sure, some sort of “Europe discount” is appropriate given the macro risk and the unappealing growth prospects for years to come. But at some point, the stocks are simply too cheap to ignore. By FT estimates, the French, German and Spanish markets trade for just 14.1, 12.7, and 13.4 times earnings, respectively. Depressed earnings, I might add. Each also yields between 3 and 5 percent in dividends. Compare this to the United States, which trades for 16.1 times cyclically-high earnings and yields a pitiful 2.1%. Are European stocks as attractively priced as they were two months ago? Of course not. But I still expect them to be among the best performing in the world over the next 6-12 months.

It’s only fair to mention the other side of the coin. If the bond market loses faith in Mr. Draghi or infighting among Europe’s politicians prevent them from making the institutional reforms needed to make the bailouts credible, then all bets are off. (Just today it was announced that the German, Finnish and Dutch finance ministers had announced opposition to aspects of the bank bailout….sigh). In the event that the reforms truly break down, investors will want to not only exit their European equity positions but exit all risky assets, as this would mean a return to the risk-on / risk-off volatility we’ve had to endure for much of the past two years.

SUBSCRIBE to Sizemore Insights via e-mail today.

Comments { 0 }