Category Archives: Japanese development

I’ve been VERY wrong about the Japanese stock market

May 16, 2013 By in Asian economic development, economics, Japanese development, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , Leave a comment

The Liberal Democratic Party retook control of the national government in Japan late last year on a platform of massive monetary stimulation aimed at shocking the economy out of its quarter-century of torpor.

Most economic effects have been as expected.  The ¥ has lost about a quarter of its value.  This has given export-oriented industries a big boost.  The price of imports has risen by enough, however, that the overall effect of devaluation on Japan has been slightly negative so far.  The trade balance will doubtless improve as Japanese citizens adjust to the tremendous drop in their standard of living that the devaluation has brought about.

Where I’ve been wrong has been in handicapping the behavior of the Japanese stock market.  In the only other recent episode of a big fall in the ¥, the Topix index (Tokyo large caps, the index professional investors use) rose as the currency declined, but only by enough to keep a dollar-oriented investor from losing money.  Yes, export-oriented stocks did better than Topix, but the overall index was unchanged in dollar terms.  I thought something similar would happen again.

Not this time, though.

Since the Abe administration took office and made it clear it would carry out its campaign promise, the Topix is up by 66% in local currency terms, meaning a dollar-oriented investor in the index has made a 25% gain.  Buyers of down-and-out consumer electronics firms like Sony have made twice that.  The long-Topix, short-¥ trade has made a killing.

As I see it, the rise in the Topix has been driven by foreigners.  Locals–never, in my experience, the canniest of investors–have  been mostly using the opportunity offered by devaluation to declare victory in their foreign investing forays and are bringing money home to put into things like real estate.

Press reports indicate new investors in Japanese stocks, including high-profile Western hedge funds, believe very strongly that the change in money policy also heralds a new era of openness to structural economic reform by Tokyo, and that foreigners will be allowed to play a significant role in the latter process.

My view, based on almost 30 years of watching Japan, is that Tokyo insiders regard devaluation as a substitute for reform, not a precursor.  I’d point to the experience of former Prime Minister, Junichiro Koizumi, who was given an overwhelming electoral mandate for reform but who resigned as PM after five mostly fruitless years (2001-2006) of trying to effect change.  As soon as he left, the Diet immediately began to reverse the progress he was able to make.

For Japan’s sake, I hope I’m wrong again.  But I’m not willing to bet on the possibility.  As for the new wave of foreigners, I find it hard to figure whether they have a much more sophisticated read on the political process in Tokyo than I do or whether they’re completely clueless.  Given that reversal of the deep social/political aversion to disruptive change should make me wildly bullish about Japan, in some sense I must think the latter is more probable.  My official position, though, is that I don’t choose to bet.

 

 

parity party on the calendar–the yen and the penny?

April 14, 2013 By in Asian economic development, currency effects, economics, Japanese development Tags: , , , , , , , 1 Comment

parity–almost

Two days ago the Japanese yen reached a low where US$1 could buy ¥99 in the foreign exchange markets.  That’s extremely close to parity between the US penny and the yen.

What makes this level shocking is that last September, one greenback would only get you ¥77.  So the exchange value of the yen has dropped against the US$ by 22%+ in a little over half a year.  Stuff like this doesn’t usually happen with the national currencies of large developed world economies.

On the other hand, there aren’t normal times in the Land of Wa.

Japan’s problem

Japan has been struggling economically for almost a quarter century, plagued by a toxic combination of next to zero real economic growth + Deflation.  A falling price level means takes more of your income to repay debt, so no one borrows.  Things will always be cheaper tomorrow, so everyone postpones spending.

This stagnation is not an accidental occurrence, as I see it.  It’s the result of deliberate policy decisions by Tokyo aimed at preserving the social and cultural milieu of the 1970s-1980s–as well as the power of the aging and hidebound executives/bureaucrats/ politicians who came to power in that era.

How so?      The Japanese workforce is shrinking as the population ages, but immigration to replace those workers is not allowed.  Moribund companies are not permitted to die.  Instead, they’re kept alive by financial infusions from suppliers, customers and local financial institutions.  Nor are such firms encouraged to streamline or refocus so they can make money again.  Quite the opposite.  The government even protects inept or indifferent managements from any shareholder attempts to compel them to do so.  In many cases–the auto companies are one shining exception–zombie-like firms destroy the profitability of entire industries.

the inflation “solution”

Faced with severe voter discontent, the recently-elected new government has decided to “cure” the economic malaise by increasing the money supply until doing so creates inflation.  That’s the main economic plank the Liberal Democratic Party ran on, so arguably the ballot box shows the measure has popular approval.  Unfortunately for Japanese citizens, however,…

…there’s little reason to think that this will do lasting good

Textbook theory says an acceleration in money growth will lower interest rates and weaken the currency.  That gives the economy a temporary boost, which will gradually subside–leaving the country with the same real growth rate as before but with higher inflation.

A whiff of inflation is nothing too horrible in Japan’s case, since the country is suffering the ills of deflation–except for the risk that domestic interest rates will rise.  That could make it far more difficult for the government to finance the country’s huge debt burden.

In some ways, we’re in uncharted waters here, however.  Textbook theory is formulated from general economic principles buttressed by observations from practical experience.  Most of that experience comes either from small economies or from a much simpler pre-globalization (no BRICs) world, however.

So far, the announcement of Tokyo’s intention to create inflation has weakened the yen by a (to me) startling 22.5%.  That represents an extraordinary loss in national wealth.  It also means that dollar-denominated items–like food, clothing, fuel–that Japanese consumers buy on a regular basis now cost almost 30% more in yen than they did six months ago.  Yes, this is inflation, but not the healthy kind–wage increases driven by rising industrial productivity;  rather, this is a substantial fall in the Japanese standard of living.

Will the loosening of money policy lead to improvement in profits for Japanese industry?  In the case of commodity-like machinery output, the short-term answer is “Yes.”  Both the EU and the US have recently expressed strong concern that Japan is attempting to export its industrial woes through hostile currency devaluation.  This means that basic industry in both areas is already being hurt by Japan’s move.

On the other hand, will you now pick a Sharp TV over a Samsung, or a Sony smartphone over an iPhone/Galaxy S4 just because the price of the former has gone down a bit?  How many more boomboxes or Walkmen will you buy?

Perhaps most distressingly, for much of Japanese industry a lower currency will only make it easier to ignore their lack of innovation and their weak general management for a while longer.

The damage done to Japanese consumers is real and it’s today.  An industrial renaissance due to looser money is unlikely, in my view, while the government defends the status quo.  As the White Queen in Through the Looking Glass said, it’s “jam tomorrow.”

recent world currency movements: stock market implications

January 30, 2013 By in Asian economic development, currency effects, Current Market Thoughts, economics, Foreign markets, Japanese development, Portfolio management, Recent Market Action, Shaping a portfolio for 2013, Strategy Tags: , , , , , , , , , , , Leave a comment

dramatic changes

Although currency movements sometimes can often be overlooked by a stock market investor immersed in the hustle and bustle of day-to-day trading action, there have been a couple of whopping big moves in major currencies over the past half-year.

Since late July 2012, the euro has risen by 12.5% against the dollar.  Over the same time span, the yen has fallen by about 16.5% against the greenback.  A quick bit of multiplication tells us this also means that the euro has risen by about 30% against the Japanese currency.

To my mind, there’s no really satisfactory general economic theory about how currencies work.  But to give a sense of perspective, inflation in Japan has been, say, -1% on an annual basis over the second half of 2012.  We’ve had +1.5% in the US.  Euroland has experienced a 2.5% rise in the price level.  Inflation differentials imply that the yen should be rising against the dollar at a 2.5% annual rate and against the euro by 3.5%.  The euro, in turn, should have weakened by 1% against the dollar and 3.5% against the yen.  The actual outcome has been far different.

Of course, there are reasons for the spectacular assent of the euro and the plunge of the yen.  Until around mid-year, many observers thought Euroland was coming apart at the seams and rushed to get their money out before the demise.  I’m sure there was more than a touch of flight capital mixed in the outflows.  Thanks to Mario Monti’s and Angela Merkel’s actions indicating the political will to save the euro, capital flows have reversed in spectacular fashion.

Newly-elected Japanese Prime Minister Shinzo Abe made it a central plank of his campaign for office that he intends to force the Bank of Japan to print lots of money.  Why?   …to weaken the yen and to create inflation.  The move could easily end in eventual economic disaster, but for now its main effect has been to drive the Japanese currency down a lot versus its trading partners’.

stock market implications

Generally speaking, a rising currency acts to slow down the domestic economy.  A falling currency gives the economy a temporary boost.

Currency changes can also rearrange the relative growth rates of different sectors.  The best-positioned companies will be those that have their sales in the strongest currencies and their costs (e.g., labor, raw materials, manufacturing) in the weakest.

Japan

The decline of the yen has given Japanese export-oriented firms a gigantic relative cost advantage against European competitors, and a significant, though smaller, one against US rivals–or those located in any country that ties its currency to the US$.  Anyone who sells products in Japan that are imported, or made with imported raw materials, has been crushed.

We’ve seen this movie before, however, on a couple of occasions.  It’s ugly.  Domestic firms lose.  Exporters will make substantial profit gains in the local currency.  But from a stock market view, that plus–with the possible exception of the autos–will be offset for foreigners by currency losses they have/will endure on their holdings.  Stocks in even the most advantaged sectors will deliver little better than breakeven to a $ investor, and will certainly rack up large losses to anyone interested in € returns, in my view.

Euroland

The EU has already had a return-from-the-dead rally, where stocks of all stripes in the economically challenged areas of southern Europe have done well.  The message of the stronger currency is that importers, or purely domestic firms in defensive industries will fare the best from here.    Although I think the preferred place to be from a long-term perspective is owning high quality export-oriented industrials, the rise of the euro has blunted their near-term attractiveness.  One exception:  multinationals based in the UK, because sterling hasn’t participated in the euro’s rocketship ride.

Ideally, you’d want a firm that imports Japanese goods into the EU.

the US

Americans are less accustomed to thinking about currency effects that investors in other areas, where their effects are more pervasive.  With the dollar being in the middle between an appreciating euro and a depreciating yen, currency effects will be two-sided. Firms with large Japanese businesses, like luxury goods companies, will be losers.  Firms with large European assets and profits, like many staples companies, will be winners.  Tourism from the EU will be up, from Japan, down.  One odd effect, which I don’t see any obvious American publicly listed beneficiary–the decline in the yen is causing the cost of living for ordinary Japanese to rise sharply, since that country imports so many dollar-price raw materials.  To offset that effect, Japan is beginning to weaken protective barriers that have kept much cheaper finished goods (like food) from entering the Japanese market.  Doubly bad for Japanese farmers, though.

the yen is now too weak to suit Tokyo?

January 17, 2013 By in Asian economic development, economics, Japanese development Tags: , , , , , Leave a comment

In recent national elections,  the Liberal Democratic Party, led by former prime minister Shinzo Abe, seized control of the Diet, running on a platform of causing the yen to weaken against the currencies of Japan’s trading partners.  The idea was to break the quarter-century trend of domestic economic weakness by giving a temporary boost to export-oriented manufacturing and to try to end the deflation that has plagued the country since the early 1990s.

Since this idea was first suggested–the inept Democratic Party of Japan was certain to be tossed out in any election–the Japanese currency has fallen by almost 15% against the US$.  Now, in a reversal of form, the LDP wants the currency depreciation to stop.

What’s going on?

Why should it matter to the rest of the world?

The Japanese economy is like a slow-motion train wreck.  So it has a certain morbid fascination to it.  Perhaps more important, for the EU and the US,  Japan is like Dickens’ Ghost of Christmas Yet to Come.  Japan has written the manual on how not to run a developed economy with an aging population.  Hopefully, Brussels and Washington are taking note.

Three points:

1.  Except for developing economies dedicated to radical economic transformation, currency depreciations never work.  Export-oriented manufacturing may get a temporary boost.  But that quickly fades.  Inefficient companies just put off necessary restructuring.  So the economy is soon back in the same sorry shape, only with higher inflation.  In other words, economically speaking, this was a crazy idea.

2.  Politicians normally choose currency depreciation over more effective adjustment methods mostly because it’s invisible–so they can deny responsibility.  It isn’t the legislators who are inflicting pain on the economy, after all, it’s the (evil) foreign currency markets.  In this case, however, even the political rationale doesn’t hold.  Currency depreciation, over the protests of the Bank of Japan, is the centerpiece of the LDP economic program.  So the LDP gets all the blame.

3. The costs of currency depreciation, in terms of national wealth, can be immense.  In Japan’s case, the cost of goods and services produced abroad is suddenly 15% higher than it was last October.  This doesn’t just mean foreign vacations or real estate purchased by the wealthy.

It also means food, clothing, fuel, electric power–anything imported into the country.  Looked at a different way, the after-tax purchasing power of Japanese savers and wage earners has just shrunk by about a quarter, almost overnight.  What a disaster!  I think it’s citizen uproar over higher prices for everyday necessities that’s causing the LDP’s about-face.

I hope the LDP has a backup plan.

 

 

Shaping a portfolio for 2013(lll): China

January 9, 2013 By in Asian economic development, China, Constructing a Portfolio, Current Market Thoughts, economics, Hong Kong, Japanese development, pink sheets, Portfolio management, Shaping a portfolio for 2013, Strategy Tags: , , , , , , , , , Leave a comment

China

Like the US, China is a complex topic with lots of moving parts.  I’ve also been investing in China-related stocks for over 25 years (hard to believe it’s been that long), so there’s an increased risk of my being distracted by details.  So, like my views on the US, I’m down to bullet points:

1.  In the late 1970s, China decided it had to embrace Western economics (not politics), because central planning wasn’t working and it didn’t want to end up like the old Soviet Union.  Like Japan before it, China pegged its currency to the US dollar and concentrated on growth through export-oriented manufacturing.

Two factors separate China from run-of-the-mill emerging countries using the Japan blueprint:

— the huge size of its population, and

–the single-mindedness with which it has pursued economic expansion.

Thirty-plus years later, China is now the second-largest economy in the world.  It’s three times the size of #3 Japan, and 80% as big as the US (using Purchasing Power Parity GDP figures).  In a handful of years, China stands to become #1.

2.  The financial meltdown in the US and the € crisis in the EU depressed demand in China’s two major markets.  China’s (very competent) economic mandarins initially added temporary extra stimulus to domestic activity to counter the effects.  But even while China was doing this, it was clear that the currency peg would, quickly enough, transmit enormous (and unneeded/unwanted) monetary oomph to the mainland economy.

Like other emerging economies, China has been spending the past couple of years trying to cool down an overheating economy.

That task has already been accomplished.

3.  In November, China completed its once a decade Communist Party leadership transition.  In the runup to this event, high-level decision-making grinds to a halt, since bureaucrats don’t know the identities, let alone the intentions, of their new bosses.  That drag on the economy is in the past, as well.

4.  Because of #2 and #2, it seems to me that the year of the Snake will be a strong one for China.  Growth may come in at “only” 8%, but that will certainly be better than most other places on the planet.  The Chinese PMI is already signalling acceleration.

how to invest

You can get some exposure by finding stocks in, say, the US or Europe, that have significant operations in China.

You can get more direct exposure by buying the stocks of Chinese companies.  As with any other equity investment, the basic choice here is whether to pick an index fund/ETF, or to actively manage–either by selecting an actively-managed mutual fund or picking the stocks yourself.

Personally, I own three funds in the Matthews family of China-related offerings.  I also have international accounts with Fidelity and Charles Schwab so I can buy Hong Kong-listed names in the local market.  Many are also available for trade on the pink sheets, although usually at considerably less favorable prices.

I’ve never been a big fan of ADRs.  In general, a foreign company only comes to the US when it thinks it can get a better price for its equity than it can from investors in its home market, who presumably know the firm and its business practices much better than foreigners.  The only exception I see to this rule is the case of EU-based tech companies, where local investors are mostly clueless.