Japan Credit Rating Downgraded By Fitch? Thank you, Captain Obvious

In an acknowledgement of the glaringly obvious, Fitch downgraded Japan’s credit rating by a notch on Monday, citing Japan’s ballooning pubic debt.


My only question is this: What took them so long?

Fitch now rates Japanese debt as an A, which is five full notches below the top AAA rating…and just a few notches short of actual non-investment-grade junk status.

The straw that seems to have broken the camel’s back for Fitch was the delay by Japan in raising its consumption tax from 8% to 10%.

Seriously? That’s where they decide to draw the line?

Japan was a solid credit before, but now, because they delayed raising taxes by two percent, their commitment to fiscal discipline is being questioned?

You might detect a little sarcasm here, but Japan’s fiscal position is no laughing matter. Japan has dug itself into a hole from which it cannot realistically hope to dig itself out. Japan won’t “default” on its debts, as they are denominated in yen and Japan can essentially print the yen it needs to pay its existing creditors. That is pretty much what is happening today, as the Bank of Japan is the buyer of substantially all new bonds being issued by the Japanese treasury.

But while outright “default” may not happen, something every bit as destructive will. Eventually, the market will turn on the yen, and the controlled decline of recent years will turn into a collapse. Sure, Japan will pay its debts. But it will be in currency so depreciated it won’t really matter.

Let’s take a good, hard look at Japan. By Fitch estimates, Japan’s sovereign debts will rise to fully 244% of GDP by year end. Whether they raise consumption tax to 10% or 110%, it’s hard to see much materially changing on the indebtedness front. Not even Greece—yes, GREECE—has a debt burden that high. At last count, Greek sovereign debt stood at about 177% of GDP.

Americans fret that their government has a spending problem…and it does. But U.S. federal debt accounts for just a little over 100% of GDP. Even during World War II, our debts only amounted to about 120% of GDP. That means today, after decades of peace, Japan’s debts are more than double the levels of the United States during the peak of the biggest war in world history.

What’s more, Japan is adding to those debts every year through chronic budget deficits. In 2015, Japan’s tax intake is expected to cover just 57% of the government budget, meaning that Japan borrows 43 cents of every dollar it spends.  Its budget deficit is expected to be over 6% of GDP this year.

Japan 10-Year Bond Yield
Japan 10-Year Bond Yield

Bond yields across the yield curve are close to zero in Japan; the market yield today on 10-year Japanese bonds is just 0.3%. And even at that rock-bottom yield, about 16% of Japan’s annual budget is interest on its existing debts. If Japan’s yields rose to anything close to the developed-world average—or to anything close to a level that would be commensurate with currency risk—interest payments alone would completely overwhelm the Japanese budget.

All of this sounds bad. But with diligent cost cutting and a commitment to fiscal discipline, Japan can reduce its debt load to something a little more manageable, right?


Let’s just say I doubt it. If Japan were a fast-growing emerging market with a youthful population, I would say that, at least theoretically, Japan could grow its way out of its debt problem. But that is simply not the case here. Japan’s GDP hasn’t grown at all, even in nominal terms, in over 20 years (see chart above). Even if Abenomics were moderately successful in reigniting Japan’s economy (and thus far its impact has been mixed at best), Japan’s history over the past two decades should teach us to have realistic expectations.

But the biggest reason that Japan is doomed is the cold, hard math of demographics. At the risk of oversimplifying, there won’t be enough Japanese taxpayers alive a few decades from now to pay the bills. Japan is already the oldest country in the world, with nearly a quarter of the population over the age of 65. By the year 2060, Japan’s population of 127 million people will have shrunk by more than 30%. And an almost unfathomable 40% of the population will be 65 or older.

So, is there a play here?

Maybe. To start, I’d avoid buying shares of Japanese stocks, such as via the iShares MSCI Japan ETF (EWJ), for anything other than short-term trades. Longer term, Japan is looking at total economic collapse, and you don’t want to be left holding the bag with Japanese stocks. More intrepid investors could consider shorting the yen or aggressively  shorting Japanese bonds via the DB 3x Inverse Japanese Govt Bond Futures ETN (JGBD).

In any of the cases above, patience will be needed. Japan has limped along with a broken economy for nearly a quarter century. There is no guarantee that the bottom falls out today. But given Japan’s debt and demographic issues, it is just a matter of time.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing he had no positions in any security mentioned.

Photo credit: Gareth Jones

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.

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.”

Is the ‘Abe Trade’ Still in Play?

The votes have been counted.  Japan’s Liberal Democrats—the party of Prime Minister Shinzo Abe—won a landslide victory over the weekend, securing control of both houses of parliament.

The implications here are huge.  Abe is as close as you can get in modern Japan to a militant nationalist, and the win will only encourage him to escalate his war of words with China.  Abe is pushing for a re-write of Japan’s constitution that would scrap some of the pacifist language written in by the United States after Japan’s surrender in World War II.

All of that is fine and good, but the question on most investors’s minds is far more focused: what does this mean for Abenomics and the “Abe Trade” of going long Japanese equities and short the yen?

Japanese stocks were mostly flat after the news, suggesting that there were no real surprises.


Looking over the past few months, we get a more interesting story.  The Japanese Nikkei Index (orange line above) took a tumble in May and early June, falling into bear market territory.  Yet taking a lot of investors by surprise, the Nikkei has since rallied and gained back most of its losses.

The yen (green line), which has moved the opposite direction, rallied over the period before giving most of the gains back.

So, it would appear that the Abe Trade is back on…at least for the time being.

If you are a short-term trader or trend follower, then there may be a little money left to be made in this trade.  By all means, go for it. But be careful, and make sure you have some kind of risk management in place.

If you are a longer-term investor or if you are less-inclined to monitor your positions closely, stay out of Japan.  Being long Japan is comparable to picking up nickels in front of the proverbial steam roller.  If you linger too long, you will get crushed.

While I try to stay objective and avoid looking at the markets through biased eyes, I admit fully that I have become something of a Japan permabear.  When I look at the country’s macro environment, I do not see any set of circumstances whereby this doesn’t end poorly.  At 240% of GDP, Japan’s sovereign debts are the highest in the developed world, and by a wide margin.  Its population is aging and shrinking (see Jeff Reeves’ recent article about the Japanese boom in adult diaper sales) meaning its tax base to support its debts gets smaller every year.  And it adds to this mountain of debt with a budget deficit of nearly 10% of GDP.

All it would take for Japan to descend into a financial meltdown would be for its bond yields to rise by a couple percentage points…which is a virtual inevitability given the country’s borrowing needs.

And topping it off, after their torrid run, Japanese shares are no longer cheap.  The Nikkei trades for 16 times expected 2014 earnings.

When will Japan’s day of reckoning come?  Frankly, I have no idea.  It will come when investor sentiment shifts and investors suddenly perceive the risk that has been there all along.  It could happen tomorrow…or it could happen in a few years’ time.  But happen it will.

If you want to continue to play the Abe trade, the second half—shorting the yen—is the less risky option.  If I am correct about Japan eventually blowing up, then the yen will fall to zero…or close to it.

If you decide to play the first half—going long Japanese equities—do so with the mentality of a short-term trader and use proper risk management.  Japan is not a long-term buy because Japan has no long-term future.  If you need a reminder, print off Jeff’s article on Japanese adult diapers and tape it to your wall.

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The First Half of the Short Yen / Long Japanese Equities Trade is Still On

Two weeks ago, I asked if the short yen / long Japanese stocks trade was over.   It appears that, indeed, it is.

The Nikkei crashed by over 6% on Thursday, pushing it well into bear market territory.  It’s now down by more than a quarter from its recent highs.

And the yen?  It has rallied and is now at a three-month high.

What’s going on here?  Has the market lost faith in Abenomics?

We shouldn’t draw too hard of conclusions here.  First and foremost, we have to remember that the Nikkei had doubled over the course of just half a year and that the yen had lost roughly a quarter of its value relative to the dollar over the same timeframe.  Some of the “hot money” that had pushed this trade to such extremes has been taken off the table.  Traders had made a killing, and it was time to take profits.

As for Abenomics, I don’t think it is a case of the market losing faith in it because I don’t believe that the Smart Money ever truly believed in it to begin with.  “Successfully” igniting inflation risks destabilizing Japan’s sleepy bond market…which in turn risks turning the orderly decline of the yen into a hyperinflationary rout.  No one in their right mind would want to be a long-term holder of Japanese equities given the risk of a credit market meltdown.  Sure, Japanese equities are cheap.  But they’re not cheap enough for that kind of risk.

The Smart Money saw a great opportunity for a short-term trade, and they took it.

But what can we expect going forward?

I expect a lot of volatile noise from the Japanese equities market that will be hard to play, long or short.  But I believe the second half of the trade—shorting the yen—still has life left in it.

The easiest way to short the yen is via the ETF market: the Proshares UltraShort Yen Fund ($YCS).

Be careful here.  YCS has been in free fall since late May, and you don’t want to catch a falling knife here.  I would recommend starting small—with, perhaps, 20% of the allocation you want to eventually have invested in this trade—and average your way in over the course of the next several weeks.

If I am right about Japan having a capital markets meltdown , the yen has a lot further to fall.

Of course, the day of reckoning could be postponed due to coordinated central bank action, or I could simply be wrong.  A lot of very smart macro traders have bet big on a Japan blowup in recent years only to be disappointed. To play it safe, use something along the lines of a 10% stop loss.

Disclosures: Sizemore Capital has no current position in any security mentioned.   This article first appeared on TraderPlanet.

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