Japan… tide finally turning?
Until recently, when you mentioned ”Japan” in the investment context, you could almost hear a collective sigh of disappointment — it was all about recession, deflation and poor investment returns.
However, sentiment does seem to be finally changing, not least because Tokyo stocks have rallied almost 20 percent since the start of the year, outperforming benchmark world and emerging indexes.
The yen has also been on a (rare) declining trend since the start of February, with the selling momentum accelerating since the Bank of Japan set an inflation goal of 1 percent in a surprise move and boosted its asset buying programme by $130 billion on Feb 14.
A closely-watched survey by Bank of America Merrill Lynch showed record optimism on Japan’s growth among fund managers, with a net 91 percent of Japanese fund managers saying they expected the domestic economy to strengthen. That’s up from a net 47 percent two months ago.
Overall, survey partipants worldwide slashed their underweight positions on Japanese equities to a net 4 percent in March from 23 percent last month. This is the smallest underweight position on Japan since August. According to Gary Baker, head of European equity strategy at BofA Merrill:
There’s quite a change in sentiment towards Japan. If you have global growth then Japan… is a big cyclical region to benefit from that. While investment story is the same, what changed there is the yen weakness… it becomes easier to play the story.
Three snapshots for Thursday
The VIX volatility index has fallen below the average level seen during the 2003-2008 pre-crisis period.
The low level of the VIX is also being matched by moves down in other ‘safe haven’ assets. The dollar is near an 11-month high against the yen, and a rise in U.S. Treasury yields is pushing up the spread between U.S. and Japanese bond yields.
President Barack Obama and British Prime Minister David Cameron discussed the possibility of releasing emergency oil reserves during a meeting on Wednesday, two sources familiar with the talks said.
While likely to be popular with many Americans, tapping the SPR alone could antagonize allies in Europe, several of whom remain unhappy over last year’s action and are unlikely to back another release.
The head of the Paris-based IEA, Maria van der Hoeven, has said in recent weeks she sees no current need for consuming nations to release strategic reserves.
Buy more yen… to increase reserve returns
Japan has not been a sexy destination for investment. In an environment of rising sovereign risk, Japan’s huge debt burden (+200% and rising) and lack of triple-A rating (Japan is rated AA-, Aa3 and AA by the main rating agencies) are not something that would attract the world’s investors, including the powerful central bank reserve managers.
However, the yen is a different story. Enjoying a safe-haven status, the Japanese currency is staying just below its all-time high around 75.90 per dollar, while it also rose to an 11-year peak against the euro in January.
JP Morgan,whose asset management arm manages $70 billion for 65 official sector clients including central banks and sovereign wealth funds, says reserve managers have been diversifying into non-G4 currencies but the strategy has not performed well.
Instead, it says, they should buy more yen.
“Diversification has targeted cyclical assets such as commodity currencies, which impart more leverage than safety to a portfolio. A much higher allocation to structural funding currencies such as the yen is required for reserve managers concerned with volatility and drawdown,” JPM says in a note to clients.
According to the latest reserve data from the IMF, central banks — which control reserves of over $10 trillion worldwide — hold 60 percent in dollars, 27 percent in euros and 4 percent in sterling and yen respectively.
This would have returned 1.5 percent in the past two years and 2.9 percent in the past five years.
It’s the dollar
Two graphs (from Scott Barber) to remind that what you get from assets depends on the currency:
The Big Five: themes for the week ahead
Five things to think about this week
TUSSLE FOR DIRECTION - The tussle between bullish and bearish inclinations — with bears gaining a bit of ground so far this month — is being played out over both earnings and economic data. Alcoa got the U.S. earnings season off to a good start but a heavier results week lies ahead and could toss some banana skins into the market’s path. Key financials, technology bellwethers (IBM, Google, Intel), as well as big names like GE, Nokia, Johnson and Johnson will offer more food for thought for those looking past the simple defensive versus cyclical split to choices between early cylicals, such as consumer discretionaries, and late cyclicals, such as industrials, based on the short-term earnings momentum. Macroeconomic data will need to confirm the picture painted by last week’s unexpectedly German strong orders and production figures to give bulls the upper hand.
FINANCIAL FOCUS - The heavy financial results slate (Goldman, JP Morgan, Bank of America, Citi) will show the extent to which balance sheets are being cleansed of toxic assets and the health of, and outlook for margins, trading revenues, etc. The relative performance of the firms reporting could put the spotlight on the split between investment banking and retail exposure. In Europe, Swedbank’s results will be watched for Baltic exposure while clarity is still being sought on what banks plan to do with the large chunk of ECB one-year money which they continue to park back at the ECB in the form of overnight deposits.
JAPANESE DILEMMA - The BOJ’s policy meeting poses thorny questions on quantitative easing (QE), with the policy debate complicated by sharp gains in the yen. The yen has risen as much as 10.5 percent in three months against the dollar and is nearing the 90 threshold which is viewed by the foreign exchanges as the point at which the Japanese authorities start ratcheting up the rhetoric. Further sustained yen gains will fuel market debate about the fallout for carry trades and for exporters — and by extension economic activity.
HOOKED ON QE - The sharp jump in yields in gilts, euro zone debt, and Treasuries seen after the Bank of England deferred any decision on expanding its QE programme gave a good indication of how bond markets could react when central banks flag that the QE taps will finally be turned off for good. Implementation of exit strategies may be some way off and producer and consumer price data from both sides of the Atlantic this week are likely to be subdued. However, base effects from the oil price peaks of 2008 are expected to fade in the coming months, leaving a less supportive inflation backdrop.
CHINA - The FX reserve debate was aired by the highest-ranking Chinese politician to date at L’Aquila summit and U.S. TICs data this week should keep the reserve holdings issue on the boil. Attention is also on Chinese domestic/trade policy following violence in Xinjiang and strains in relations with Australia over Rio Tinto staff detention. Any escalation in either could prompt investors to review the potential for regional outperformance.
from Raw Japan:
Whither the yen — a withering yen?
The yen's fall against the dollar the past few weeks has been remarkably fast, and calculated from where it is now around 97.70 yen, the dollar has jumped nearly 9 percent this month, on track for its biggest such gain since August 1995.
The yen surged last year as the worsening financial crisis forced investors to unwind risky carry trades - meaning they had to buy lots of yen - under the belief that Japan's economy and banks were holding up through the storm.
Only last month, the yen hit an over-13-year high of 87.10 per dollar. So why has the Japanese currency fallen so fast?
Analysts tell me one reason is some traders and investors who thought it would continue to rise, perhaps as far as 80 or even 70 yen, got out of such bets.
One catalyst was data showing the sharpest economic contraction in 35 years in the last quarter.
The bleak data seems to have further soured overseas investors' views on Japanese stocks. Foreigners have been been net sellers for 12 straight weeks to the tune of 2.97 trillion yen, around $30.4 billion.
Carry on falling
Graphic evidence from Investec Asset Management (below) highlighting the demise of the carry trade. It shows returns from borrowing low-yielding currencies such as Japanese yen to buy high-yielding ones over the past 7-1/2 years or so. There has been a roughy 50 percent decline since the end of July.
End of carry trade unwind?
Merrill Lynch’s monthly poll of fund managers around the world has a bit of a surprise in the small print. More investors now reckon the Japanese yen is overvalued than see it as undervalued. This is the first time this has been the case since Merrill began asking the question, said by staff to be about eight years ago.
It clearly reflects a 13 percent dive in dollar/yen this year and a 24 percent plunge in euro/yen. But does the new view of value suggest that the unwinding of the carry trade is over? Another question from the Merrill poll shows hedge fund deleveraging levelling off.
