FYI | May 30 2013
Global Markets – Japan comes back into focus?
“When in May stay away” is the normal catch-cry for traders this time of the year, although so far you would wonder given record highs in the US equity markets. With only a few days to go, Tuesday night's high in the Dow then subsequent rejection provides another tough hurdle the market will need to pass. However, if you were a Japanese investor the saying holds true with the market dropping 13% over the last week, with sellers continuing to line up on the sidelines. Expect more weakness to come.
Since July last year the market has virtually doubled on stimulus programs and with traders all of sudden locking in profits some ugly questions are starting to be asked. In this week's Bulletin we focus on Japan as it looks like a major pressure point for the market. With the savage spike in bond yields, which triggered the sell-off in equities, investors are starting to realize some negative effects stimulus may have on the economy and markets. Granted the Japanese economy has been suffering from deflation for 15 years and has high government debt to GDP as a result of factors outside its control, but the moves do provide some clarity on the problems ongoing stimulus measures will ultimately have on economies. Problems which we have reiterated more than once, and problems that even the IMF is seeking clarity on. The IMF, in a recent comment about the Fed’s disengagement of stimulus, has suggested the central bank needs to be more transparent on how it intends to withdraw stimulus, and through which products, as this uncertainty needs to be clarified so that markets can confidently trade on. In Japan it’s a different and developing story.
The USD/JPY has been an interesting trade since we identified a rounded bottom back in Oct 2012 at US76.00/80.00. We have had a few good trades and the philosophy of buying the dip has served us well. However, it looks as if the trade is starting to become crowded. Last week when we saw a spike in the 10-year JGB [Japanese government bond] to around 1%, the equity market dropped 13% and the currency dropped 3 yen. In reality this move in JGBs should not be happening; hopefully it is just a blip and the resumption of the trend will continue. However, we have to question the reasons for the moves and whether we are about to enter into a period of consolidation.
Perhaps the market has just moved too far too fast whilst searching for its “terminal point” or, for that matter, too fast for government rhetoric to follow up. Prime minister Abe’s policy, or as it has been dubbed, "Abenomics", is all about monetary stimulus, and the 70 trillion JGB buyback QE program instigated by the government and the Bank of Japan is designed to keep monetary policy loose and low, with the intention that loose monetary policy will weaken the yen and stimulate domestic growth. The target inflation rate the BoJ is looking at is 2% and with the economy having been stuck in a deflationary environment for the past 15 years, the new Abe government is determined to break the cycle. However, the move last week has dented the enthusiasm for the trade and set the scene for a review of the philosophy being utilized.
A weaker currency is used to stimulate exports. However, what happens when the speed of the deprecation, ie by 36% in seven months, makes exports 36% cheaper and imports 36% more expensive and a stock market that has nearly doubled in value since Nov 2012. It’s a shock the economy needs to deal with and as government debt to GDP is at 211%, with the prospect it could blow out to 245%, it’s a worry. It’s a brazen move to be implementing volatile policy at a particularly vulnerable time. Basically, the shock 10-year JGB move to 1% was a concern, as in the normal course of events if investors believe in reflation via Abenomic methods, they would sell the JGB, as rates would be low for sometime and better yields could be found elsewhere. The BoJ would be happy to be on the bid buying bonds. However, the unexpected bounce in yields is another story. Yields already were low on monetary stimulus measures, which had failed to ignite the economy. The BoJ QE programs to buy back bonds are meant to be providing additional liquidity in a similar vain to the Fed. However as we are already questioning the benefits of the Fed's program we also have to question the success of the BoJ. Perhaps more so given the current government debt to GDP ratio.
The market looks to be focusing on two aspects as a result of the spike. Firstly, the effects of the additional liquidity/stimulus may result in an inflationary spike and secondly, the risks are that the anticipated government revenue may not be enough in the beginning to help the government service its debt, hence the spike in the bonds. Further if the yields blow out it would be costly for the government. Adding to these concerns we have a market that once convinced will look to factor in the terminal point, and yields will rise. Whichever way you look at it the prospects look set for higher yields. Not good if you hold equities and are short the currency. The 10-year JGB looks to have a cemented high in place so the prospects for the above to occur could become a reality. It is arguable that in difficult times hard decisions need to be made. Japan is no stranger to these. In the 1930’s a do or die decision to reinflate the economy, was made by Korekiyo Takahashia with great success. Perhaps we are about to witness the same. Lets hope so.
It is interesting to also consider the recent spate of comments coming from the Japanese administration, with both PM Abe and BoJ head Kuroda confirming policy and concerns the Japanese economy would face from an increase in long term interest rates. Last week's move, or flash crash, set the market talking about inflation moving higher, which they say will help kick-start spending. Others disagree, but this is what makes a market. As it stands, technically and fundamentally, a great argument can be mode for the currency to strengthen, so perhaps the trade is a little crowed at the moment. It is a great time to take profits and stand aside from the market, waiting for a better entry point. We are sure that both the government and BoJ have not finished with their trades.
Locally, the market seems to be holding on to gains regardless of the negative trade data and confidence figures. We need to see more economic news in order to conclude the trend for the next month or so. At the moment we feel investors in respect of the local market are focusing on economic data in China, developments in Japan and the fact that overseas holidays are becoming very expensive. The AUD continues to fall and we feel that equities will continue to remain soft. The prospects going forward continue to look soft.
So in a nutshell, it’s a nervous time and with a couple of days left in May we feel that the old adage “when in May stay away” just may be reconfirmed for another year.
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