Japan is complex story. From the eyes of a western investor a surreal world where valuations seem entirely out of step with western metrics.
Imagine a world where the yield you recieve for lending your capital to your government (A very indebted government with 200% debt to gdp) is less than 0.95% per annum for ten years. The 4 year yield in Japan is at 0.22%. It is clear that capital holders, in Japan, have totally discounted any positive inflation for years to come. Whats even more surreal is that these ultra low yields are, nonetheless, positive yields for investors and therefore higher than the negative yields seen for US capital holders advancing loans to their government at 2% p.a. for ten year T-bonds. Of course inflation is the key here. Japanese inflation has been negative for many years. A sustained negative inflation rate environment has compressed yields to near zero. Capital holders have given up on growth simply happy to accept any poistive return. So it is that a 4 year yield of +0.22% p.a. is still a positive yield of 0.77% vs a negative 4 yield yield in the US of around -3.5% p.a. Note, the Japanese capital holder is still 427 basis points better off than his US counter part just so long as inflation stays subdued in Japan.
Nonetheless, the japanese consumer, just like his western counter part, has responded to the year year decline in interest rates. The Japanese savings rate has been a secular decline mirroring the western consumer’s savings rate. Increasing government social security provision (54% of all japanese government expenditure for 2011/12) along with falling interest rates has discouraged savings. Japanese savings rates, once very high, have fallen to other developed nation levels.
Its a black irony not lost on me that just as the Japanese baby boom generation are about to reach for their capital (savings) these are about to be expropriated from them via the printing presses.
The implications for Japanese companies that had large balance sheet exposures to domestic asset markets over the last two decades was immense. Banks and property companies capitalizations where destroyed. Twenty years ago Japanese banks, insurance companies and property companies dominated the world as the largest/strongest capitalised companies in the world. Following twenty yeas of deflation later they struggle to populate the top twenty list now. How the mighty have fallen.
Given the scenario above, where capital holders in Japan having totally given up on inflation, it was very very interesting to hear the BOJ come out this week and accept a new 1% inflation. As we know central bankers can always and everywhere create positive inflation. Prices of assets and goods are determined by the amount of money chasing them. Central bankers (along with domestic banks) control the value of each unit of money in a society so it is that capital holders should listen and take note of what the BOJ say. Interest rates cannot go any lower in Japan nominally. But certainly the 427p.a. basis point 4 year yield can be squeezed not by adjusting downwards the 0.22% p.a. yield on JGBs (Japanese government bonds) but by increasing the inflation rate. Logically this will likely lead to decompression in ‘safe’ such yields such as JGBs and other bond debt markets. But the BOJ can engage in asset purchases or QE to prevent decompression in bond markets. Rates can stay low so Government and corporate debt markets can borrow at a subsidized rate for as far as the eye can see. Private capital’s 427 basis point yield will be compressed therefore and the value of the JPY will fall destroying bond market allocated capital.
Financial repression has gone global following the BOJ announcement this week that they have ‘taken advise from (mr money printer himself) Ben Benanke”.
http://www.businessweek.com/asia/man-bites-dog-bank-of-japan-wants-more-inflation-02152012.html
Putting it all together. This is wonderful news for asset markets and particularly the Nikkei (as well as local asian markets as capital will flee Japan just as it is America). The death of the long secular bear market in Japan has been forecast by many commentators over the last few decades. In truth only the monetization of debt markets and a sustained and massive debasement of the JPY will end this secular bear it seems. This is the conclusion the BOJ has finally reached.
Private Japanese capital is to squeezed into assets. Positive yields will, over time, go negative and look more like American, British and European yields. Fixed income will destroy developed nation capital parked there, over time. The implications for the very unloved property, insurance and banking equity markets world wide are clear. Industrialists will come and go as each nation in the old g4 win and then lose their race to debase their currencies. Industrial stocks will provide the beta but be mch more cyclical than their Bank, Prop, Insurance related cousins. Precious metals will do very nicely in this environment and are no where near their tops. They will likely see a mania way beyond the nasdaq 2000 bubble before their secular top is printed. Emerging market consumer related and asset market related stocks will also do very nicely with a small question mark on their industrial sectors due to the developed market currency debasements. Material sectors should also fly as private capital flees debt markets and ‘risk’ assets see significant capital inflows.
Finally here, the price chart of the usdjpy over the last 5 years showing the break of the downtrend. We are at a price resistance line having come a long way very quickly from a long term consolidation.
It looks like a long term bottom is in place from the chart. The technical trend line broke, then retraced then broke the down trend again to the upside. This is a very positive price reversal signal. A text book price signal. The CCI shows positive divergence to form this breakout of the downtrend. Price is above the 200 and the 50 with the 50 about to cross the 200 day moving average. This is also usually very positive. As always, central bank actions can change the technical picture and money flows but, for the moment, capital is no longer flowing to the jpy, the technical picture is very positive, if a little over bought.
The probability, from a fundament and technical view point, is for a continued money flow away from the jpy. As shown here below comparing the G6 most liquid currencies in the last year. The trend, as regards the JPY, is in her infancy and will, imo, affect many asset markets. Here a 3 month fx comparative chart.
Out of time but this week was significant in many respects. Markets will continue to move up and down but the secular old g4 trend of currency debasement and financial repression are getting into full gear. The implications for ‘risk’ asset market are immense and still at a very early stage in the big scheme of things.
As always, its simply my opinion. Any capital you have accumulated is your private capital that you must protect and develop as your research, reading and risk appetite dictates.
I’m off skiing. Have a great weekend whatever you get up to.
Rich
p.s. Interesting report on Japan household balancesheets from 2008 here.. Nothing of significance in terms of ratios, etc has changed since the report was written. japanesehhdebt
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