Japanese individual investors saying no thank you to JGBs

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The Mainichi Shimbun (original in Japanese) reported early Thursday that Japanese Government Bonds’ (JGBs) popularity is rapidly falling among individual investors. Beginning in 2003, the Ministry of Finance (MoF) has sold two types of JGBs (a fixed-rate 5-year and a variable-rate 10-year) four times a year to individual investors. However, as interest rates have been held at zero (remember ZIRP) to near-zero levels for years, Japanese individual investors may finally be voting with their purses. The October 5-year issue had a coupon of 0.6%, the lowest since the program began in ’03, and less than half the peak coupon rate of 1.5% in July ’07.

The MoF now only expects to raise Y1.3 trillion (US$14.3B) this year from individual investors, down from a prior estimate of Y2.4 trillion, and considerably lower than the record Y7.2 trillion raised in ’05. Through the end of this September, individual investors held Y27.7 trillion or 4.6% of JGBs outstanding. The MoF argues that recent individual investor reluctance for JGBs is not an issue because their weighting is so low. However, it goes without saying, as the article accurately points out, that it is an issue, as the government is poised to take on even more debt in the face of declining tax revenues.

In fact, the MoF is reportedly planning to introduce a fixed three-year JGB for individual investors next July. At this time, it’s hard to imagine a warm welcome, let alone a return to previous years’ embracing of JGBs. The MoF may be right in not being very worried, since it can just pressure domestic institutional investors to pick up the slack. So whether individual investors like it or not, it’s probably the case that they will remain proxy buyers of JGBs.

Japan watchers and investors will readily recognize and perhaps even sympathize with the plight of domestic savers. The golden days of the yen carry trade seem so distant with US$1/Y90-level support so sticky. It’s a real shame that Japanese companies don’t pay quarterly dividends as is common practice in the U.S., for instance, since household, quality Japanese companies are in some cases paying dividends at multiples of what JGBs offer. The desperate search for yield could be called off. Instead of chasing the latest overseas investment fad or making risky leveraged forex trades, maybe something more productive could be achieved.

Disclosure: The author has no direct exposure to JGBs, and does not believe a crisis is looming for Japan despite David Einhorn’s position, and in spite of the serious problems the country faces but continues to bundle into a bumbling status-quo. 

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.

Shanghai selloff overshadows DPJ, Nikkei

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The DPJ’s rise (and the LDP’s fall) is no longer debate material, but a welcome reality. As expected, the yen exhibited strength, and looks poised to test ¥92. The Nikkei meanwhile was quite volatile, gapping up, hitting a new ytd high at 10,767, tumbling into the start of the afternoon session to a low of 10,423, to close down 0.4% at 10,492. The star of the day, if you will, was the Jasdaq, up 1% to 50.49, right around its ytd high. Of course, now that the DPJ is in power, the real challenge is to keep campaign promises and stick to them, even if there is near-term pain — rather than postponing the pain as has often been the case.

In terms of the markets and forex, the DPJ has almost certainly created a situation for further yen strength (and sustained relative yen strength after everyone piles into the trade and eventually moves on). Domestic-demand stocks, while not immune to certain negative externalities of a strong yen, are likely to be favored over exporters. The exporters, whether they like it or not, will have to get accustomed to a stronger yen. To summarize the first day of trading after Japan’s historic election, it is suffice to say that politics is front and center as it should be, but the market reaction was diluted by both a dose of reality and by the 6.7% selloff in Shanghai.

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.

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 inadvertently intervenes to soften yen

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The Japanese yen (JPY) is still “relatively” strong, but it has weakened by a pretty significant amount against the US$, nearly 10 points, in recent weeks. With much buzz of yen intervention leading up to the recent softness, one would have thought the MoF ran out of patience and intervened. Well, in fact, it kind of did in a sense, since the now disgraced former Finance Minister Nakagawa couldn’t handle his glass at the G20; and the latest Japanese political news scandal involves a case of potential campaign contribution fraud by the opposition party — maybe now is the JCP’s chance. So, with Japan so concerned about “reputation risk,” one would assume a national policy would call for carefully cultivating it. However, in addition to the above, the musical chairs of inept prime ministers post-Koizumi and the ceaseless political gaffes, have instead resulted in carelessly damaging Japan’s reputation. Should the yen find relative strength again — and it just might considering the basket case of currencies out there — unless there are more snafus within the GoJ, then I continue to believe there should be no deliberate intervention since it would still be premature at this point given deteriorating global economies.

Yen ETFs traded in the U.S.:

CurrencyShares Japanese Yen Trust [[FXY]]
Ultra Yen ProShares [[YCL]]
UltraShort Yen ProShares [[YCS]]

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.

Japanese stocks ‘fairly’ undervalued

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The author’s intent is not to be misleading, but rather to be as frank as possible, regarding the longstanding debate of whether or not Japanese stocks are truly undervalued. In short, the answer is  no. I no longer believe Japanese stocks are undervalued, not to the extent that I once did, and not to the lengths that some pundits and money managers try to make a case for. In fact, I would argue that Japanese stocks may best be described as being closer to fair value instead of being deeply undervalued. I mean Japanese stocks, for the foreseeable future, may be destined to be “undervalued” by traditional metrics, but fairly valued by the market and in relation to the economy. Continue reading