{"id":34025,"date":"2012-12-04T23:46:34","date_gmt":"2012-12-05T04:46:34","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/2012\/12\/japan-is-a-dead-man-walking\/"},"modified":"2012-12-04T23:46:34","modified_gmt":"2012-12-05T04:46:34","slug":"japan-is-a-dead-man-walking","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2012\/12\/04\/japan-is-a-dead-man-walking\/","title":{"rendered":"Japan is a Dead Man Walking"},"content":{"rendered":"

By The Sizemore Letter<\/a><\/p>\n

All subcultures have their rites of passage.\u00a0 Marine recruits have basic training.\u00a0 Fraternity boys have hazing.\u00a0\u00a0 And macro traders have the Japan short.<\/p>\n

It seems that you\u2019re not part of the club until you\u2019ve lost money shorting Japan bonds or, more recently, the yen.<\/p>\n

You\u2019ll do it for all the right reasons, of course.\u00a0\u00a0 We all do. \u00a0And chances are good you\u2019ll still lose on the trade.\u00a0 It happens to the best of us.\u00a0 Even hedge fund \u201cmasters of the universe\u201d like Greenlight Capital\u2019s David Einhorn.\u00a0 Japanese bond yields have defied the bears for years, as if they are held low by the weight of an immovable sumo wrestler.<\/p>\n

Or maybe not.<\/p>\n

I recently wrote that Japan would be the next shoe to drop<\/a> in the global financial crisis, and I got a fair amount of hate mail for it from other investors.\u00a0 (\u201cHate mail\u201d may be a little too harsh.\u00a0 We\u2019ll go with \u201cstrongly-worded professional disagreement\u201d).<\/p>\n

Yes, Japan may be the most heavily-indebted country in the world with debts that far outweigh those of Greece, Spain or Italy.\u00a0 But this debt is held domestically, so the thinking goes, so Japan is not at risk of an attack of selling by the bond vigilantes.<\/p>\n

This is flawed thinking for a number of reasons, which I\u2019ll address in a second.\u00a0 But before I do that, I want to ask a simple question:<\/p>\n

Why not <\/em>short Japanese bonds and the yen?<\/p>\n

Seriously, you have nothing to lose.\u00a0 The Japanese 10-year<\/a> yields a pitiful 0.69%, less than half the yield of the also pitifully low 10-year U.S. Treasury.\u00a0 The laws of mathematics are pretty straightforward here.\u00a0 Bond yields can\u2019t go below zero.\u00a0 Shorting Japanese bonds at these levels is a coin toss in which \u201cheads, I win\u201d<\/em> and \u201ctails, I have virtually no room to lose.\u201d <\/em><\/p>\n

And the yen?<\/p>\n

Traders are lining up to short the yen right now; the short position in the currency recently hit a five-year high, as measured by the U.S. Commodities Futures Trading Commission.\u00a0 Whenever I see a crowded trade like this, I get a little suspicious.\u00a0 But I can certainly understand their bearishness.<\/p>\n

The yen has been in a raging bull market since the carry trade \u201cblew up\u201d in 2008.\u00a0 Traders had been using the yen as their funding currency for years because rates were so much lower in Japan than anywhere else in the world.\u00a0 But once the dust settled after the 2008 meltdown, rates in the United States and Europe weren\u2019t much higher.\u00a0 And with the Eurozone looking like it was about to come unwound, parking a little cash in yen seemed like a less bad idea.<\/p>\n

All of this contributed to the yen bull market.\u00a0 But this trend has gone about as far as it can.\u00a0 As I wrote in the last article<\/a>, Japan\u2019s domestic population is dying.\u00a0 Japan is the oldest country in the world, and more adult diapers are sold there than children\u2019s diapers (Seriously, stop and think about that for a second).<\/p>\n

With a shrinking domestic market, Japan needs exports to stay above water\u2026which means that they need a weak currency.\u00a0 The high price of the yen (along with weakness in Japan\u2019s export markets in the U.S. and Europe) sent Japan\u2019s famed trade surplus into deficit for much of 2011 and 2012.\u00a0 You think Japan\u2019s leaders are happy about that?<\/p>\n

The fair question to ask is \u201cWhy now?\u201d\u00a0 Japan has been a wreck for 20 years, and the country has lived with high debt levels for a long time.\u00a0 Why is this time different?<\/p>\n

To start, Japan\u2019s probable next prime minister, Shinzo Abe, has made it a point of policy to lower the value of the yen with unprecedented levels of quantitative easing.\u00a0\u00a0 He also wants an explicit inflation target of 2-3%.\u00a0 It\u2019s hard to see interest rates staying at less than 0.7% if inflation gets anywhere near that level.<\/p>\n

If the yen continues to crack, we may actually get a decent short-term rally in Japanese stocks.\u00a0 But whatever you do, don\u2019t fall in love with this trade.\u00a0 If interest rates rise significantly, Japan will have a hard time rolling over its debts\u2014it\u2019s colossal, 220% of GDP debts.\u00a0 And if we start to see rates creeping up, I expect to see a lot of volatility in Japanese equities.<\/p>\n

All of this is compounded by the fact that Japan will have to increasingly fund its large budget deficits (roughly 10% of GDP per year) in the international bond market.\u00a0 The Japanese savings rate is not what it used to be.\u00a0 In fact, at 1.9%, it\u2019s lower than America\u2019s now.<\/p>\n

Do you think international bond investors\u2014those same investors that drove Spain and Italy to the brink of needing sovereign bailouts\u2014will continue to roll over Japanese debt at current rates?\u00a0 Yeah, me neither.<\/p>\n

When Japanese rates begin to rise, I believe we will have the short opportunity of a lifetime in Japanese assets\u2014stocks, bonds, the yen, you name it.<\/p>\n

Investors wanting to short Japanese bonds can go about it several different ways.\u00a0 One option is the Powershares DB Inverse Japanese Government Bond ETN (NYSE: $<\/span>JGBS<\/a>)<\/strong>, though you should be careful with this one.\u00a0 It\u2019s thinly traded.<\/p>\n

Shorting the yen via ETFs is a little easier with the ProShares UltraShort Yen ETF (NYSE: $<\/span>YCS<\/a>)<\/strong>.\u00a0 And shorting Japanese equities can be done with the ProShares UltraShort MSCI Japan ETF (NYSE:$<\/span>EWV<\/a>) <\/strong>or by simply shorting the popular iShares MSCI Japan ETF (NYSE: $<\/span>EWJ<\/a><\/strong>).<\/p>\n

In the meantime, be patient.\u00a0 Unless you want to join the \u201cmacro traders who lost money in Japan\u201d club.<\/p>\n

Note: For an interesting piece that takes the other side of the argument, check out Steven Towns\u2019 bullish piece on Japanese equities<\/a>.\u00a0 \u00a0Towns makes a compelling case for several Japanese blue chips, and many I would consider buying <\/em>after a major crash.\u00a0 But for now, I see the best opportunities in Japan coming on the short side.\u00a0 \u00a0<\/em><\/p>\n

Disclosures: Sizemore Capital has no positions in any securities mentioned.<\/p>\n

The post Japan is a Dead Man Walking<\/a> appeared first on Sizemore Insights<\/a>.<\/p>\n

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