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Cowley: Japan - a conspiracy wrapped inside an enigma

Cowley: Japan - a conspiracy wrapped inside an enigma

You wonder whether internet conspiracy theorists would get a tad paranoid if you were to point out that there appears to be an elite group of transnational conspirators who control all the conspiracies, are connected to each other and have been controlling all conspiracy theories for thousands of years.

No doubt they would have a couple of sleepless nights over it. It is tempting to feel the same way about a small group of people who have been constantly calling for the imminent demise of Japan with marginal anecdotes that confirm their feverish analysis.

To them the situation must already seem like an organised global conspiracy, such is the weight of the evidence in their favour and the lack of tangible reaction to it.

All you can really say about Japan is that each day brings the inevitable one day closer.

Pressure comes and goes and the Japanese Apocalyptors emerge out of the shadows, shake their fists at the world and then retreat again, having not got what they want.

And what they want is the collapse of the Japanese yen and a rise in bond yields to (according to some) in excess of 10%.

To put that into perspective, if that were to happen to a ten-year maturity Japanese Government Bond (JGB) today, the value would go from about ¥100 to about ¥55, a 45% price decline.

If you were to combine that with a yen movement back to levels seen in the past fifteen years then on top of this you would experience a 75% fall in the relative value of the currency.

As you can see, calling the turn in the Japanese market carries with it very high stakes indeed. If you measure yourself against a market index containing Japanese assets and the yen, its probably the easiest performance you will ever see.

If you are an absolute return player, then the combination of a yen bond decline coupled with a short on the yen will be too much to resist even for a small portion of a portfolio.

That elusive killer pattern

Psychologically, you understand also why many managers are desperate to find the killer pattern that is telling them that the turn is imminent.

They need to confirm their bias but the real incontrovertible piece of evidence remains enigmatically absent. If we were on the internet, you would think that a conspiracy was at work.

Those looking for signs of deterioration focus on the Japanese debt to GDP ratio, now running at over 200%, or the increasingly desperate attempts to keep the quantitative easing programme going; in the last round, in September, the Bank of Japan didn’t even think it necessary to tell the Ministry of Finance they were going to announce a tit-for-tat response to the US and European versions.

Or they could point to stories that the Japanese life assurance companies are becoming net sellers of Japanese government bonds as the population ages and starts drawing down on its savings, whilst simultaneously there appears to be a concerted campaign to attract foreigners to the Japanese government bond market to replace capital short falls.

Most of the warning signs have been known about for a long time and yet they have had no conclusive effect. So here is my contribution to those desperate to call the turn; in many respects what people have concentrated on is effects and not causes.

The Japanese alarm bells are ringing

Ultimately the demise of Japan will be caused by how its companies function domestically and in the broader context of the world and if you look at that, then all the alarm bells are now ringing.

Take for instance Japan’s balance of trade with the rest of the world. There was a time when Japan had enough income from trade to pay for itself. In recent years this has clearly collapsed and now for the first time in two decades it has fallen into deficit. Of course, the spat with China and the boycotting of Japanese goods in the short term hasn’t helped but still the trend is alarming.

If you start digging inside of this phenomenon you see something else. Most people, when they think of Japanese goods, think of electronics and cars.

The recent news that the household name Sharp Corp has, in its own words, ‘material doubts’ about its own survival, should give you a clue as to what is coming next. In fact if you add together the profits of Sharp, Panasonic and Sony you can see that Sharp isn’t alone in its material doubts.

What were healthy collective profits have now turned into decidedly unhealthy habitual losses. It is quite conceivable that we could see a number of household electronics names simply disappear in the very near future.

At the same time the seven car manufacturers contained in Nikkei 250 equity index, whilst still in business, have seen collective profits fall 47% since 2007. It’s an ugly corporate picture.

The demise of profits from the electronics companies is coincident with a rise in the value of the Japanese yen relative to the US dollar.

Companies like Sharp have been hit hardest by their product mix and the decline in global television sales, but the rise of the yen has exaggerated an already bad situation. Repeat this across a number of industries and you understand why the Bank of Japan (BOJ) is now desperate to join in the global central bank race to bolster the economy through more and more stimulus.

Ultimately, the BOJ wants the yen to decline to help out the manufacturing base. If their stated aim of creating inflation in the economy can be realised in this way then that will be all to the good.

But in the process bond yields will have to rise if Japan is to supplement domestic savings with foreign capital and compensate investors for inflation and declining credit quality.

In that case its best to avoid the yen and put a precautionary short on the Japanese government bond market. Now seems as good a time as any to begin that process.

Cowley manages the Citywire Selection Old Mutual Global Strategic Bond fund. According to Lipper the fund has returned 19.9% in the three years to 6 November versus 16.2% rise  in the benchmark.

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Stewart Cowley
Stewart Cowley
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