Japan the End of the Beginning 2013 04
Transcript of Japan the End of the Beginning 2013 04
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Japan The End of the Beginning Macro Economic Research April 2013
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Putting the Recent Moves in ContextJapanese equities are up nearly 60% from the November 2012 lows, making it by far the bestperforming market 2013 YTD (up 33% in USD compared to 11% for the S&P500).
Perhaps the most important driver of the move has been the close to 30% depreciation in theYen. Since replacing aging hawk Shirakawa as the new Governor of the Bank of Japan, Kurodohas set a target of achieving 2% inflation within 2 years, and accelerated QE to asset purchasesof some $75bn per month.
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Japan The End of the Beginning Macro Economic Research April 2013
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The sharp move has resulted in some brokers scaling back expectations, for example MorganStanleys April 15 piece, the cover page copied below.
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I think they are wrong and a longer term view is necessary to evaluate the moves, a forty year chart of
the Yen is shown below.
The longer term chart of the Topix index also puts the recent appreciation into context.
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Also important is current valuations. Despite the gains the Topix 100 index still has a higher dividend
yield (1.7%) than any time prior to 2008 (the gold line in the chart below). Earnings growth in 2013 is
expected to be around 50%. In addition, the majority of dividend-paying companies have very healthy
balance sheets (huge net cash balances are common in deflation-honed Japanese balance sheets) and
hence it is easy to conclude that dividend payouts are likely to grow rapidly in 2013 and 2014.
With cash yielding nothing and the long bond trading around 0.6%, on a relative basis equities are
yielding 2.8x bonds, higher than any time prior to 2012. This relative valuation imbalance can
normalise in two ways a collapse in dividends (which is not plausable near-term given earnings growth
and balance sheets) or a sell off in bonds raising yields, or some combination of both.
Given the massive QE buying of bonds, any sell off in the face of this would be valuable evidence that
Japanese market participants are starting to believe the BoJ can achieve their 2% target. That belief
could be very dangerous what real yield would be appropriate for bonds in that environment? What
would a significant move up in nominal yields mean for the banking sector (who are massively long
bonds)?
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Japan The End of the Beginning Macro Economic Research April 2013
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Current Positioning of Japanese Households
The Bank of Japan flow of funds data provides an up to date (December 2012) snapshot of household
financial assets. The graphic below compares households in Japan, the USA and Euroland, who have
financial assets of Y1547tr ($15.5tr), $54.4tr and EUR19.3tr ($25.1tr) respectively.
Two decades of low nominal growth and deflation have massively impacted which financial assets
Japanese households own. The largest asset by far is cash on deposit with local banks, despite no yield
historically an attractive asset given persistantly declining prices. The second largest asset, Insurance
and Pension reserves, is primarily exposure to Yen bonds. For further insights into this the BofJ data can
be used to drill down into some of the investment catagories shown above to enable an evaluation on a
see-through basis.
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Japan The End of the Beginning Macro Economic Research April 2013
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InsurersFinancial Assets Japan Total Y403.8tr ($4.0tr)
InsurersFinancial Assets USA Total $7.0tr
A similar exercise can be done for Pension Fund Assets (Japan (top) Y125.4tr = $1.2tr, USA (bot.)
$11.2tr)
While Outward Investment in Securities makes up some 12.5% of Insurance and 20.9% of pension
assets, the majority of these exposures are likely to be currency hedged back into Yen, so while there
may be some yield pick up, they may not be an effective hedge against Yen weakness.
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Japan The End of the Beginning Macro Economic Research April 2013
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The aggregated see through data enables us to evaluate Japanese Household Financial asset exposures.
With some 76% of assets invested in local deposits and bonds, and some 16% invested in equities and
foreign securities, Japanese Households are taking a huge bet that the Bank of Japan will not be
successful in reaching a 2% inflation target. The actual positioning is even worse than illustrated aboveas most of the foreign security holdings via insurance companies and pension funds are currency
hedged back into the Yen. Ironically given where yields are, buying equities or foreign bonds will not
only provide protection of capital in a weaker Yen/higher inflation environment, but will also
immediately increase yielda very rare win/win. What historically was a low risk positioning (cash in
the bank) is now fraught with risk of real loss of capital in a very plausable scenario of higher inflation
and pegged rates.
Foreign Involvement
Foreign participation in Japanese equities has dramatically increased. For example, the Wisdomtree
Japan Hedged Equity ETF has increased in size from $600m to $7.1bn in 2 quarters. Despite the sharp
price appreciation, the portfolio still looks attractively valued, especially given the strong earningsgrowth expected near-term in Japan.
%age of Total
Financial Assets
Japan
Total
Bonds Cash Equities Off
shore
Sec
Infn
Proof
Total
USA Equities
Equities 6.8 6.8 6.8 32.8 32.8
Investment Trusts 4.0 0.8 0.6 2.3 2.9 11.8 5.5
Insurance 21.1 15.3 0.2 1.3 3.1 4.4 10.8 2.9
Pension Funds 6.6 2.2 0.3 0.7 1.6 2.3 17.3 8.5
Bonds/loans 2.1 2.1 9.5
Cash on deposit 55.2 55.2 14.6
Other 4.2 3.2
Total 100.0 20.4 55.7 9.4 7.0 16.4 100.0 49.7
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Conclusion
Japanese households are well positioned for a continuation of the two decades of slow nominal growth
and deflation. They are terribly positioned for a successful reflation. I expect the process of reducing the
existing risky positioning to have a considerable impact on Japanese equities and a lesser but still
significant impact on the Yen going forward. This process has hardly begun, and can be expected to take
many years.
Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the
beginning.
Winston Churchill, November 1942
Kevin Cousins is a portfolio manager at Brait Capital Management Limited. ("BraitCM"). This article isprepared by Kevin as an outside business activity. As such, BraitCM does not review or approve materials
presented herein. The opinions and any recommendations expressed in this article are those of the
author and do not reflect the opinions or recommendations of BraitCM.
None of the information or opinions expressed in this article constitutes a solicitation for the purchase orsale of any security or other instrument. Nothing in this article constitutes investment advice and any
recommendations that may be contained herein have not been based upon a consideration of theinvestment objectives, financial situation or particular needs of any specific recipient. Any purchase orsale activity in any securities or other instrument should be based upon your own analysis and
conclusions. Either BraitCM or Kevin Cousins may hold or control long or short positions in the securitiesor instruments mentioned.