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Abe’s Third Arrow: Guess What, It Won’t Matter

Japanese prime minister Shinzo Abe has officially let fly his much-anticipated “third arrow,” announcing on Monday a series of economic reforms that included, among other things, a corporate tax cut.

His first two arrows were, of course, a loosening of monetary policy that included a massive quantitative easing program and a fiscal stimulus package.

The first two arrows—and particularly the quantitative easing program—were wildly successful in pushing down the value of the yen and in reviving the animal spirits in the Japanese stock market.  But their effects on the real economy were mixed at best, and I would argue that over the long term will make not one iota of difference.  Japan will never get its economic mojo back.  Its aging and shrinking demographics all but guarantee that Japan will eventually slide into oblivion.

And as for the third arrow, I expect its effects even in the short term to be virtually nil.

Let’s take a look.  At 35.6%, Japan has the second-highest corporate tax rate in the world after the United States, which tops out at about 40% after allowing for state and local levies. Yes, not even the notoriously high-taxing French extort as much money from their companies; France tops out at about 33%.

Details have not been released, but early estimates suggest that Japan’s corporate tax rate could fall to as low as 20%.

So, given the high current tax burden faced by Japanese companies, a reduction in the tax rate should mean an investment boom in Japan, right?

All else equal, yes.  But alas, all else is not equal.  As Capital Economics notes, return on investment in Japan is low by global standards due to existing overcapacity and, in any event, Japan already has some of the highest levels of capital spending in the G7.  While a lower tax bill might boost corporate profits and give Japanese equities a jolt, it’s hard to see this unleashing a Reagan or Thatcher-style economic transformation.

I touched on Japan’s problems in my last issue of Macro Trend Investor.   Remember, Japan is the oldest country in the world with a quarter of its population already over the age of 65.   Japan’s population peaked seven years ago at 128 million and hasn’t stopped shrinking since–Japan has about a million fewer citizens every year.  By 2060, the Japanese government estimates that Japan’s population will have shrunk to 87 million people, and 40% will be over 65.

In a modern consumer economy, an aging and shrinking population is devastating to growth.  Fewer people mean fewer consumers—and less spending, unless you believe that a smaller consumer base will somehow buy more goods and services per capita.  That could only happen if real income per capita outpaced population decline, which is a scenario that is hard to envision.  Rising income would only come with rising production per capita…which, again, only makes sense in a stable or growing population.

Likewise, older consumers buy much less than those in middle age (certain items like healthcare notwithstanding).  So again, an aging and shrinking population means less spending and slower economic growth.

This is why Japan’s recessionary conditions are not cyclical but structural.    Think about it: Why would builders build new homes if there are fewer people to live in them?  Why would companies invest in new capacity if there are fewer consumers to sell to?

Hey, I’m a believer in small government, and I’m generally very favorable towards tax cuts.  I see nothing wrong with Abe’s decision to lower taxes in a bid to make Japan more competitive.  But let’s get realistic.  It’s not going to be a game changer.

The third arrow will also have policies aimed at getting Japan’s women back to work.  Details are yet to be released, but again, it’s hard to see this having a big impact.  Unless Japan can somehow convince its women to have large, 4-5 children families and institute economic policies that would somehow make that affordable in modern Japan (never mind changing social attitudes keeping women at home that have endured for centuries), it’s hard to see any of this mattering much.

If you want to play the inevitable failure of Abenomics, look for opportunities to short the rallies using  an inverse ETF or fund such as the ProShares UltraShort MSCI Japan (EWV).  Or for a safer bet, you can short the yen via the ProShares UltraShort Yen ETF (YCS).

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Thinking About Buying Japanese Stocks? Let Me Get You a Duffel Bag, Some Gasoline, and a Lighter

It’s official: Japanese stocks are in correction.

After closing at a recent high of 16,291 on Dec. 30, the Nikkei was down by about 14% through yesterday’s close. The iShares MSCI Japan ETF (EWJ), the most popular Japan ETF, is down a more modest 9%, due in part to currency effects (the yen tends to rally during “risk off” market conditions).

I’m not big on technical definitions. It’s not particularly important to me whether a market is in “correction,” meaning down 10%, or whether it is officially a “bear market,” meaning prices have declined by 20% or more. What matters to me is what I can expect going forward.

So with that said, what can we expect from Japanese stocks?

Let’s start with valuation. The stocks that make up EWJ collectively trade for 21.79 times earnings, which is on the pricey side, particularly given Japan’s sluggish growth. Of course, trailing P/E can be over- or understated depending on what stage of the economic cycle we are in, so the Shiller Cyclically-Adjusted P/E (CAPE) can be a useful tool to smooth out the noise.

Well, based on the CAPE, Japan has the third-most expensive market in the world, after Sri Lanka and the United States. (And yes, Sri Lanka does indeed have a stock market. I was as surprised as you.)

Looking at the EWJ and the Japanese economy, it’s hard to see how a premium valuation is warranted. Despite all attempted to ignite inflation, the specter of deflation lingers. Sure, Japan’s CPI rose 1.3% in December … but virtually all of that was due to rising energy costs and distinctly not rising consumer prices. Excluding food and energy, Japan’s CPI was up 0.7%.

I suppose it might be good that inflation is tame given that Japanese wages have fallen for 19 consecutive months and are now at a 16-year low.

If I sound a little down on Japan, it’s because I am. While I’m open to the occasional short-term trade, I am definitely what you would call a Japan perma-bear — you won’t find me recommending the EWJ any time soon.

Last year, writing about Japan’s bid for the 2020 Olympics, I wrote that if you considered Japanese stocks a viable investment, you should “close your brokerage account, withdraw the cash balance in a duffel bag, then douse it in gasoline and set it on fire. Because if you believe Japan is investable, you’re inevitably going to lose your money. The fiery duffel bag will help you skip a few steps and save some time.”

Aside from my belief that the Olympic games are of questionable economic value to the host country, I consider Japanese stocks and the yen to be long-term shorts for two related reasons: debt and demographics.

Debt and Demographics Will Weigh Down EWJ

Japan has the highest sovereign debts in the world, quickly approaching 250% of GDP. That’s well more than double the size of America’s debt load, and most of us consider the U.S. to be far too heavily indebted for its own good. And Japan shovels massive amounts of new debt onto the pile every year with budget deficits that have averaged 8% to 10% of GDP since 2008. In 2013, 46% of all government spending was financed with debt.

At the same time, Japan’s population is aging and shrinking. At the risk of oversimplifying, Japan’s debts continue to balloon even while the number of Japanese citizens available to pay it back gets smaller every year.

There is not realistic way out of this for Japan, which means major trouble for the EWJ in the long term. The Japanese bond market has been quiescent, and yields remain ridiculously low given the macro risk that Japan presents. The Japanese 10-year yields a pitiful 0.6% — more than two full percentage points below the U.S. 10-year Treasury. This has been made possible because the Bank of Japan buys 70% of all Japanese government bonds, though it has resulted in a weaker yen.

Still, if I am right about Japan eventually having a sovereign debt meltdown, the yen’s declines of the past years will look almost quaint. The yen will effectively fall to zero.

That will make paying back Japan’s mountains of debt a lot easier, of course. But it will cause ordinary Japanese citizens — and particular its pensioners — a lot of pain.

If you want to trade Japanese equities, be my guest. Any asset, no matter how fragile its fundamentals, can be a decent short-term trade. But the real play here — and the one that I view as almost “risk free” over a longer time horizon — is shorting the yen.

As always, use common sense when trading.  You can be “right” about a short and still lose a lot of money if you get caught on the wrong side of a short squeeze. An ETF option to consider in lieu of shorting the yen directly would be the ProShares Ultrashort Yen (YCS).

But if you’re still considering the EWJ, I’d point you to a duffel bag and a zippo lighter.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends. This article first appeared on InvestorPlace.

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Mea Culpa: Shorting Japanese Bonds

You don’t get every trade right, unfortunately.  Sometimes, even the best-thought-out investment thesis turns out to be flat-out wrong.

My biggest blunder of 2013?  Shorting Japanese bonds.

In the June issue of Macro Trend Investor (formerly the Sizemore Investment Letter) I recommended readers buy shares of the PowerShares DB 3X Inverse Japan Government Bond ETN (JGBD), a leveraged ETN that bets against Japanese government bonds. I ended up selling about six weeks later at a modest 2.6% loss, but it’s not the portfolio loss that made this my mea culpa for 2013 but rather the opportunity cost.  I could have made a fortune in Japan by playing my cards differently.

Let’s flash back to May.  Abenomics has been in effect for about five months, and Japan is starting to see its first flashes of inflation in years.  The Fed’s initial tapering comments have turned world debt markets upside down, and Japan’s 10-year bond yield has soared from 0.6% to 1.0% in just weeks. JGBD

The moment I had been waiting for appeared to have finally arrived.  The bond vigilantes had awoken from their long slumber and had at last come to rout the Japanese bond market. It certainly took them long enough. Japan’s sovereign debts, at 250% of GDP, are the highest in the world, dwarfing those of the U.S. and Europe. And with annual budget deficits at close to 10% of GDP, Japan has been adding to that debt load at a speed that should be alarming to anyone who cared to look.

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…  It’s a debtor’s nightmare.”

The house of cards was kept up by Japan’s high domestic savings rate.  But as Japan’s population has aged and a much larger percentage of Japanese citizens are now retired, the savings rate has plummeted.  At less than 2%, the Japanese savings rate is now lower than that of “spendthrift” Americans. 

With Japanese investors no longer in a position to soak up their government’s new bond issues, it left two potential buyers—the international bond market and the Bank of Japan.  And at the time, the Bank of Japan already bought 70% of the new bonds issued by the Japanese government. As I wrote in the June issue of Macro Trend Investor, “The way I see it, there are two possibilities here.  Either the 10-year sinks back into its long trading range and the day of reckoning is postponed for a while…or things get really choppy really fast.”

Well, as it would turn out, the day of reckoning was indeed postponed.  Calm returned to the Japanese bond market, and yields sank back to 0.6%. If I had it to do over again, I would have simply jumped on the macro bandwagon of going long Japanese equities and short the yen.  An ETF that essentially follows this strategy– WisdomTree Japan Hedged Equity (DXJ)—is up 52% over the past 12 months.

Live and learn…

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends.

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Japanese Bond Market: Armageddon Postponed…For Now

‘You can’t call yourself a global macro trader until you have lost money shorting Japanese government bonds.’

John Mauldin delivered that one-liner, which he attributed to George Soros, in his outlook for 2013.

Alas, it appears I’m now part of the fraternity. I lost money shorting Japanese government bonds this year.

Japan 10 Year

In May and June, it looked like the bond vigilantes had finally awakened from their long coma. The 10-year yield more than doubled, shooting from 0.44% to nearly 1.0% in less than two months. The bond market seemed to believe for a moment that Abenomics might—just might—be successful in shaking Japan out of its two-decade deflationary funk.

So much for that idea. Yield have trickled lower ever since, and the 10-year now yields 0.64%…or about 75% less than the 10-year Treasury yield in the U.S. One prominent Japanese analyst sees the yield falling all the way to 0.25%.

This is madness.

At the risk of whipping a dead horse, Japan is sleepwalking into a major debt and currency crisis. It is not a matter of “if” but “when.”

Related: “Japan Distracts Investors With Olympic Five-Ring Circus

Video: “China, Japan and their Demographic Time Bombs

As I wrote earlier this year, 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.

All of this might be manageable if Japan were a young and growing country. But it’s not, and it never will be again (or at least not in our lifetimes). Japan is the oldest country in the world, a place that sells more adult diapers than infant diapers. It’s population—and tax base—is shrinking, and its national savings rate—once among the highest in the world—is now lower than that of the United States. This means that the Japanese government cannot depend on a pliant domestic investor base to lend it money. It will have to depend even more heavily on the Bank of Japan or—worse—go to the international bond market cap in hand.

At some point, the bond market is going to collectively realize that the game is up and that Japan’s massive debts—currently pushing 250% of GDP—are not payable. As yields rise, the Bank of Japan will be forced to intervene, which will cause the value of the yen to plunge. In short order, Japan will shift from a deflationary monetary regime to a hyperinflationary one.

That day isn’t here yet. If anything, the bond market is more complacent now than it was a year ago. But when it comes, you will have your choice of available trading options. In my last attempt, I used the PowerShares DB 3x Inverse Japanese Govt Bond ETN(JGBD), which is a leveraged version of the PowerShares DB Inverse Japanese Govt Bond ETN (JGBS). Both are viable options for individual investors.

WisdomTree also has a product in the works, one that would pair a bearish bet on Japanese bonds with a long position in U.S. bonds.

With yields already as low as they are, your risk of loss is tolerable. In fact, your greatest risk is not to your wallet but to your reputation: you could end up becoming a member of the illustrious club of macro traders that shorted Japan too soon…

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he had no position in any security mentioned. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

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Japan Distracts Investors With Olympic Five-Ring Circus

“Tokyo 2020 Olympics could be shot in the arm for struggling Japan.”
NBC News

“The successful 2020 Olympic bid signals new hope for Japan.”
Time Magazine

So, that’s all it took.  Twenty years of economic stagnation and all Japan needed to get back on its feet was that the summer Olympics be hosted in its capital.  And after two decades of secular bear market, Japanese stocks are a buy again.  Such a shame no one thought of this sooner.

If you believe that, I recommend you close your brokerage account, withdraw the cash balance in a duffel bag, and then douse it in gasoline and set it on fire.  Because if you believe Japan is investable, you’re inevitably going to lose your money.  We might as well just skip a few steps and go directly to the fiery duffel bag.

But aren’t the Olympic Games good for the economy?

That’s the received wisdom.  But the evidence here is sketchy at best.

London hosted the 2012 Summer Olympics, and by the UK’s own estimates, ticket sales boosted British GDP by a whopping 0.2% in the third quarter of 2012. That’s hardly worth mentioning.

Hotels and food and beverage services picked up a little during the quarter the Olympics were hosted.  But the final analysis by the British government was that the overall impact was modest, and that consumption dollars spent on the Olympics might have simply “displaced other activity.”  In other words, an Olympic ticket came at the expense of a movie ticket that might have otherwise been purchased.

But wasn’t it good for employment?

Not really.  Quoting the UK Office for National Statistics, “Employment agencies showed some strength in the quarter and it is possible that some of this strength was related to the Olympics. However, there was no direct evidence from survey respondents to support this.

And hosting the Olympics isn’t free.  It cost the UK £9 billion to host the games, which amounted to £142 for every man, woman and child in the country.   (This is the part of the tab that the government picked up; private sponsors paid for quite a bit more.)

Of course, London’s transportation and infrastructure were improved in preparation  for the Games, and the UK will continue to reap the benefits of those improvements for years to come.  That has value, even if it is hard to quantify.

But would this matter to Japan?

Absolutely not.

Japan expects to spend about $6 billion building, among other things, 11 new sporting venues and 10 temporary ones.  But Olympic expenses rarely come in under budget;  Russia’s 2014 Sochi Olympics are on track to cost $50 billion, and the 2012 London Olympics went over budget by nearly 400%.

And the last thing Japan needs is new infrastructure.  At the risk of sounding alarmist, in another few decades there will be no Japanese left to use it.  Japan’s population shrunk by 200,000 people last year, and Japan is the oldest country in the world.  A quarter of the population is over the age of 65…and that number creeps up every year.

Hosting the Olympics provides the proverbial bread and circuses for the population, but it does nothing to address the country’s long-term problems.  With sovereign debts approaching 250% of GDP—and with fewer Japanese taxpayers to service that debt every year—Japan is heading towards a sovereign debt meltdown.

Japan’s domestic market is dying.  Not even Japan’s world-class multinationals see opportunity there today.   As a case in point, Suntory Beverage & Food (Japan:2587), one of Japan’s largest consumer staples companies, announced today that it would be buying the Lucozade and Ribena drink brands from Britain’s GlaxoSmithKline (GSK) for $2.1 billion as a means of diversifying outside of Japan.

Suntory has been aggressively expanding outside of Japan, where the company already generates just shy of a third of its revenues.  Expect this to continue, as it is the company’s only outlet for growth.

So, with all of this said, are their pockets of opportunity based on the Olympics bid?  Maybe.  But I wouldn’t get too attached, as the companies best positioned to profit have already seen their share prices jump.  Taisei Corp, which built the stadium for the 1964 Olympics, saw its shares jump by 17% on hopes that it will be involved in the 2020 games.

The best course of action?  Move on.  Ignore the Olympic hype and seek your investment opportunities elsewhere.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

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