Domestic and overseas factors a plenty for Japan

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More often than not, it is overseas factors that have the largest influence on trading in Japan. However, from time to time there is enough commotion domestically that also warrants the attention of investors. Unfortunately, the cacophony coming out of the government these days is more concerning than usual (e.g. Japan Post management/reform, debt moratorium, JAL, etc). But let’s not forget earnings season is here.

Following is a market summary of last week’s action courtesy of the Tokyo Stock Exchange:

Despite the decline in the American exchanges reflecting weak corporate financial statements, the market continued with slight gains from the previous week backed by the strong tone of the Asian stock market. Further into the week, rising prices of oil and other commodities in the commodities market led to buying centered around resource stocks as the market strenghtened. Heading into the weekend, while there were positives with the yen falling to the 91 yen-per-dollar level, easing concerns over deterioration in corporate export estimates, many uncertainties such as the reconstruction of JAL and the direction on the moratorium remained. In addition, a wait-and-see sentiment grew amongst investors as they chose to wait for the announcement of July-September period financial statements by domestic corporations. As a result, the market struggled to make any headway.

Relief for Japanese exporters?

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This brief post was inspired by a Bloomberg story on Asian currency strength — a good read, by the way. My thoughts: an even stronger Korean won would bring some relief to Japanese exporters. However, it’s not clear just how much (for instance, consider the volume of autos sold by JP vs SK) with such subdued demand (sans government gimmicks for autos). At this point, the currency story is driven by the depreciating dollar.

Strong yen the new norm as Japan poised to reform?

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Interesting developments in the Nikkei ahead of the parliamentary election at the end of this month, which at this point looks as if it will finally bring an end to LDP rule. A foreign exchange rate of $1/¥94 would have been practically inconceivable prior to the “Lehman shock” (as the Japanese refer to the genesis of the financial crisis), let alone a stock market rally. And now, ahead of what appears to be a DPJ (opposition party) that will let the yen appreciate and focus more on domestic demand (rightfully so), the stock indices are showing no fear of the yen.

A sustained rally in conjunction with even more yen appreciation bodes especially well for the domestic-oriented stocks, of which there are plenty — many that still have saliva-inducing valuations. However, exporters remain the headline grabbers, and it is not clear just how much yen strength can or will be tolerated (one suggestion is ¥87 is the trip wire, a level reached early this year, and a level not seen previously since the mid-90s). That being said, again what makes this all very interesting is that although the strong yen makes Japanese exports less competitive (great instead for instance, for South Korea [[EWY]], it does allow them to invest more in production overseas, a win-win for the Japanese and local FDI recipient economies.

What worries me though is the pace of reform(s) versus expectations, assuming a DPJ victory. Meantime, there is no debating the fragility of the domestic/global economy and the recovery thus far in equities. Domestic and overseas investors are very fickle and just as quickly as money has been flowing in, it can reverse course equally as quickly. The seemingly conservative, opportunistic play would be to go long the yen [[FXY]]. The DPJ’s financial advisors (and by extension, one of them possibly being tapped as finance minister) have already gone public saying they don’t intend to intervene in forex, except in extraordinary cases. Another play would be to look at the smaller-cap funds like [[DFJ]] and [[JSC]], but unfortunately, these are not very liquid and are quite fragmented. Time-permitting I will look at posting some specific stock picks.

At the time of publishing, the author does not own any long/short positions in the funds mentioned.

The perils of overcapacity in Japan

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“Recession ends in Japan,” and headlines to that effect portray a different picture than the real one on the streets. In fact, despite the headline rebound in GDP, propping open the hood shows that the outlook for Japan is a return to status quo, little to nil export-driven growth at best, and raises the likelihood of further deterioration. The Nikkei and other benchmarks have had a nice run along with the pretty much global equities rally. However, the GDP was baked in, thus the opportune profit-taking, and meanwhile, serious issues persist, such as a lack of domestic demand and industrial over-capacity.  Even without further government stimuli and/or a return to conspicuous lending and consumption in the West, it is not clear there is any impetus for either the Japanese government or the nation’s biggest companies to take steps in fostering a more balanced economy.

At the time of publishing, the author did not have open long or short positions on any Japanese benchmark index/fund.

What a run on the dollar could mean for Japan, the yen

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In 1996, in The Future of Capitalism, Lester Thurow observed the following:

When a run against the dollar starts, there are enormous amounts of money that can, and will, move into appreciating currencies. Sixty percent of official reserves and 50 percent of private reserves are currently held in dollars. Those funds will certainly move, but they will be a small fraction of the total funds avalanching down the slope. Financial speculators will pile on the downward trends in the dollar and the amounts moving will be  many times the world’s dollar holdings …. Those whose debts are denominated in the appreciating currencies (most likely yen and marks) will find the real value of their debts explode — evaluated in their own currency or dollars. Many will be unable to repay their yen- or mark-denominated loans. Financial institutions in Japan and Germany will take big losses as foreigners default on their loans.

Mr. Thurow’s observation suggests that the yen would appreciate — something it has done and sustained since Sept. ’08. However, the implications of an even more significant surge in the yen (with a corresponding plunge in the dollar), suggests that it would be detrimental to Japanese financial institutions — and we have witnessed the kind of mayhem that problems at banks can bring to the broader economy, let alone the effects of currency appreciation on exporters.

It seems then, that a lot of the presumed yen appreciation would be short-lived, since damages to the financial sector would likely result in downward pressure on the yen. What is not readily clear today, is how much exposure the financial system, excluding the BoJ/MoF, has to the dollar. In fact, given the significant foreign reserve holdings of the BoJ, it could be the case that a run on the dollar, while certainly resulting in chaos initially, would compel the government to finally look beyond the current account and do much more to encourage domestic-demand.

US$/JPY 2-year chart (source: Yahoo! Finance)

dollar - yen - 2 year chart

At the time of publishing, the author had no position in JPY/USD.

Japan lost, but not dead, in deflation

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For Japan, the 1990s are commonly referred to as the “lost decade.” Those that know me are aware that I look beyond that and actually regard a quarter-century as the appropriate “lost” duration. However, if one really thinks about what has transpired and where we are today, it is rather impressive that Japan continues to function in much the same way. Similar to Jesper Koll, who is now head of Tantallon Research, I find promise in Japan’s sustained, and comparatively large, investment in capex.

The problem for equity investors is one of procyclicality. And unfortunately, the global recession has displayed all the things that could go wrong and did (among them, the velocity of capital fleeing; widespread asset correlation; and the lack of sovereign unity towards a concerted acknowledgment and solution). Meanwhile, interestingly, Japanese companies keep plugging away, while both domestic and overseas consumers, and investors, alike, keep shying away. Unsurprisingly, I see no change in the procyclical behavior of people, whether in government, the markets, or among consumers. It almost seems like a catch-22 to be publicly traded.

In closing, as we rapidly approach the extended Golden Week holiday, let’s remember that the economic situation could be far worse than what it is. A decent chunk of companies will report earnings prior to GW, while a majority will be reporting after. The mood seems to be one of deflated expectations that go hand-in-hand with deflated results and outlooks. Although deflated does not mean dead, it means for the time being a misguided cap on the promise of what could come out of all the capex. The reality is that the best way to play Japan is either to be a trader, or to look for dividend yield supported by stable cash flows. In all likelihood, the Nikkei remains range bound: 7,000 at the bottom and 9,000 to the upside.

Thoughts on Nakagawa and on investing in Japan

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Former Japanese Finance Minister Nakagawa should never have been at the press conference that did in his career, and now has the Japanese press gone mad discussing “reputation risk.” It is disturbing that he was even allowed near the table. Equally troubling is how BoJ Governor Shirakawa didn’t preempt some questions, especially the one’s directed at him. Instead of fielding questions, he bobbled, and quite frankly, made himself look ridiculous by association. I would go as far to say that if the Japanese are so concerned about “reputation risk” that the journalists should have done the right thing and helped Nakagawa exit stage right, immediately, after becoming aware of his condition. They could have exposed him on the side or in back, instead of in front of the world.

As for Japanese stocks: I still believe that as a whole, Japanese stocks are being priced fairly by the market. Readers may have noticed how we are now rather quietly approaching last year’s low levels, which are effectively near the post-bubble trough and quarter-century ago levels. Japan may have been first into recession, but it is almost certain not to be first out — in fact, aside from the late-05 to early-07 period, Japan had basically never really exited. The current administration’s proposed economic stimulus for Japan is insignificant and deficient; and a recovery still depends more on a rebound in consumption in the US and EU, something not likely to happen soon enough or meaningful enough. Therefore, I don’t think there is any urgency for intervention to soften the yen. It would be premature. In addition, I see no rush to buy for instance, iShares MSCI Japan Index ETF [[EWJ]]. The worst case scenario is the status quo of depressed equities and relative yen strength, a double whammy.

UPDATE: Borderless Conventional Banking Failure

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No surprise that the BoJ kept rates unchanged at 0.1%. That a return to deflation is expected comes as no surprise either, since in reality, deflation never really ended, even when commodities surged last year. Meanwhile, the Japanese are left in the same predicament, with next-to-zero returns on deposits and no real need or desire to consume beyond necessities. Unenviable circumstances for both individuals and businesses, alike.

The “borderless conventional banking stupidity failure” refers to the clipped text below. With exports plunging and domestic demand continually depressed, it’s unnecessary to obsessively cater to the big players idling plants and curbing expansion. Rather it’s of utmost importance to ensure that lending not only continues, but does so without excessive stringency, at the SME and individual level, in order to have any hope of minimizing the effects of prolonged deterioration of the economy. This is a simplified argument, but the crux of the problem, especially in Japan (or I could say “even in Japan” despite all the cash held by companies and individuals — innate risk aversion exacerbates the problem). And again, a truly unenviable situation (regarding the lending climate), but in this case, one not so different than what we are witnessing, say for instance in the U.S.

clipped from www.marketwatch.com

BoJ holds rates unchanged; sees deflation ahead

The BoJ’s quarterly survey of bank-lending practices, released on Thursday, showed large financial institutions lowered lending standards for large firms, kept them unchanged for medium-sized firms and tightened them for small firms and households.

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Recession confirmed in Japan — tell us something we don’t know

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No need to get excited over the fact that the Japanese economy has now contracted two consecutive quarters (no shooting the messenger). That was largely already factored into equities, thus explaining the severely depressed levels registered of late. However, as The Economist reported in its latest edition, the “Toyota shock” of a sharp decline in expected earnings (-74% fiscal y-o-y) reverberated across Japan, bringing home the realization, to some, that stocks may not be so cheap anymore. So, it may be the case that we are closer to fair value, in spite of a market that pretty much trades at book value. Continue reading

Awaiting a sell-off as reality strikes again

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The benchmark Nikkei 225 has gained 33% in the last six trading sessions since bottoming at a 26-year low at 7,162 on October 27. However, to put the surge in perspective: from the start of October to that bottom, the Nikkei shed an even more impressive 37%. So at a close yesterday of 9,521, the N225 is still nearly 2,000 points from its Oct. 1 close of 11,368, which as I’ve said many times before, is far, far from its 2007 peak levels exceeding 18,000. Continue reading