Article Reviews, Thoughts, Trading

Review of Current Arguments On The Japanese Market

I have summarized some of the bull / bear arguments below. In a nutshell, the bull argument is that funds are buying, the bear argument is that the real economy is still not recovering. Both arguments can be true, so what does that mean?

It’s the actual buying and selling that moves prices, so yes, over the short-term (read: months), the Nikkei can well be driven by these fund flows. However over the longer-term (read: more than 1 year), prices can’t escape the pull of the state of the real economy.

It is interesting to note that after the news came out that Soros is buying Japanese stocks, the Nikkei found a bottom quickly and rebounded aggressively (helped by the 175,000 U.S. job gains data last Friday, which pushed up the USD-JPY) from ~12,400 to 13,300 (a 7.25% gain just in the U.S. session), and that is followed by a move up to ~13,600 (a 2.25% gain) today. That is a gain of 1,200 points over 1 overnight session + 1 day session. It makes the 20% drop from 16,000 seem to be not a big deal at all, just something that can be easily recovered in a couple of days. These are the kind of movements that hedge funds need (and hence they create) to make the returns they require.

In conclusion, as a trader, Ed Seykota’s message rings true here as well, junk the news, just continue to play according to the price action.

Bull Arguments

  • The Japanese Government Pension Investment Fund (GPIF) has just changed its target asset allocation as follows
    • Domestic bonds 67% to 60%
    • Domestic stocks: 11% to 12%
    • Foreign bonds: 8% to 11%
    • Foreign stocks: 9% to 12%
  • George Soros is buying shares of Japanese companies again, “from big global blue-chips to medium-cap growth stocks” because “it expects Japanese economic figures and earnings to pick up”. This is after he made $1 billion buying Japanese stocks up and dumping them in May before the sell-off (which was probably caused by his dumping), and shorting the Yen (which explains the movements in the USD-JPY).
  • Mitsubishi UFJ Morgan Stanley Securities
    • It’s a correction and an opportunity for longer-term investors to step in…  Japan is starting to change and that’s not priced in yet.

Bear Arguments

  • JGB bond yields are going up, so the spread between JGB bond yields and the bond yields in the U.S. and Europe are narrowing.
    • This negatively impacts carry trades using the Japanese yen (these are in danger when the borrowed currency’s interest rates rise or when the borrowed currency appreciates).
    • As carry trades are unwound, Yen appreciates, which is negative for the Japanese stock market.
  • Nomura (Richard Koo)
    • ECB introduced a new monetary stimulus program last September which made hedge funds fear that the Euro can collapse. So they moved their funds from Europe to Japan, resulting in the stock market run up.
    • Japanese institutional investors stayed in the bond markets and did not join in the stock market because they don’t think QE works as there is little private demand for funds. Hence bond yields did not change.
    • However when Japanese market sentiment improved, there is concern of inflation, so Japanese institutional investors sold JGBs as a hedge, which led to higher JGB bond yields.
    • The higher bond yields resulted in higher mortgage rates. However there is no recovery in the real economy.
    • Without additional lending activity due to an improving economy, banks’ financial positions will suffer when interest rates rise. Without additional tax revenues due to an improving economy, the Government’s financial position will suffer when interest rates rise.
    • Further gains in equities will require stronger corporate earnings and a recovery in the economy.
  • Deutsche Bank
    • Japanese stocks also saw a large correction after rising sharply in 2005-2006. The Nikkei Average rose from below 12,000 in August 2005 to above 17,500 in April 2006 due to expectations of progress in structural reforms after then-PM Junichiro Koizumi called a snap election on postal reform. The index corrected sharply in June 2006 to around 14,000 then rose to above 17,500 through end-2006. However, it took eight months for stocks to exceed their previous peak after bottoming.
    • It is therefore natural to assume that the Nikkei Average will correct for several months even if it eventually rises above 16,000.
  • UBS
    •  It’s possible we could see a stagflation scenario, where you see inflation in asset prices but no real growth… If you don’t have growth, then you end up with a potential Armageddon story, something we would call Abegeddon.



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