Japanese Equities: An Elusive Value Trap

No doubt David Einhorn (Greenlight Capital) is an astute investor. Recently he declared his bearish view on JGBs (Japanese Government Bonds), which subsequently has generated heavy interest among financial and political circles. Hats off to Gwen Robinson of FT Alphaville for solid ongoing coverage of the latest JGB tale (see JGBs and the ‘end’ of the short-squeeze fest). My take is as follows:

Regardless of whether Einhorn still has his short trade on or not, the chips are stacked against him and any copycats. It’s a fat chance for opportunistic hedge funds, since JGBs, even with their paltry yields (and circumstantial concerns), have both sizable and perpetual domestic demand. As I said in my last post on this topic, in spite of subdued individual investor demand, there is always an obliged patron of JGBs (the domestic institutional investor), which in the collective can fend off any offensive.

On the surface, Japanese investors sure seem like masochists, largely (and in the author’s opinion, mistakenly) shunning their own depressed equities, while settling for skeletal JGBs and feeling compelled to chase overseas trends. I used to think they were unpatriotic, in a sense, for not being buyers of domestic stocks. However, it turns out they are exceedingly patriotic given that even if they’ve lost their appetite for JGBs (in the case of individual investors), they’ll be silent holders one way or another via proxy, thanks to institutional money managers.

The Einhorn-JGB story is a reminder to Japan bears that no matter how shaky the shoji rice paper sliding doors and tatami floors appear, the pillars are quite strong and have reinforcements. As I discovered last October (’08) when the Nikkei tumbled to 1982-levels, the seemingly disastrous cross-shareholding system in Japan actually turned out to be one solid floor for equities. With the addition of timely pension fund-buying, the two effectively stopped the hemorrhaging.

So it is, Japan remains an enigma to outsiders. JGB shorts with a prerequisite nine lives. And value investors stuck in, or already having pried themselves out of, the most elusive value trap.

Comments

[hock:]

JGBs will remain solid like a rock as long as Japanese total domestic savings of US$15 trillion overwhelm the huge total government deficits of US$7 trillion. There is still a spare change of US$8 trillion. Many heroes had died shorting JGBs over the past 20 years. US T-Bonds will be a different story. A naive academic money printer as FED Chairman obsessed with defending his thesis on fighting the Great Depression, missing out the truth of history of printing money into poverty, will ensure US T-Bond is a better short.

Nov 15 08:59 AM

[Mad Hedge F...:]

bcf The collapse of the Japanese government bond market has long been the holy grail of the international hedge fund community. Unfortunately, it has remained just that for nearly 20 years, much talked about, unattainable, and some would say imaginary. During the early eighties, I took the entire pension fund of the Foreign Correspondents’ Club of Japan out of US dollar bonds and put it into JGB’s, then yielding 10%, earning the eternal gratitude of the staff there. Even today, I am showered with free drinks and lunches when I visit Tokyo. After the 1990 stock market crash, JGB’s rocketed on a flight to safety bid, the ten year eventually reaching an unimaginable yield of only 0.46%. During this decade, we have largely traded in a 1.20% to 1.90% range. Every wave of government stimulus spending brought hopes of an imminent collapse in bond prices. But the country’s gun shy institutional investors weren’t buying it, and the end result was soaring national debt, a still stagnant economy, and 1,000 bridges to nowhere, some of them truly gigantic. Hedge fund guru, Julian Robertson, annually wrote a nine figure check to the JGB market anticipating a rate spike which never appeared. However, the day of reckoning for the JGB market may at last be coming. The savings rate has dropped from 20% during my time there, to a spendthrift 3%, because real falling standards of living leave a lot less money for the piggy bank. The national debt has rocketed to 200% of GDP, and 100% when you net out government agencies buying their own securities. Japan has the world’s worst demographic outlook. Now that the country is entering its third lost decade, unfunded pension fund liabilities are exploding. I’m not saying this is going to happen tomorrow. But when the break does come, you can expect the big hedge funds to dog pile in. And if JGB’s do go down the crapper, can the yen be far behind?

Nov 15 09:59 AM

[notsosmart:]

i have had business dealings with the japanese & they think very differently when it comes to finance,advertising & sales.this is true of other countries & it pays to learn as much as possible before commiting your money.if you have something they want they will learn your ways but the other way around you better be on your toes.

Nov 15 10:20 AM

[John Aislabie:]

One of many curious conundrums is that as the demand for JGBs drops (if it does - and I can see little reason for it to increase) the yen will go down. This invariably is seen as benefitting the exporters, whose shares then rise and whose factories start to hum as people go back to work. This pushes the yen back up and restores peoples faith in the yen pushing back up the JGBs. Japan then settles back into an export led economy, with consumers once again being largely ignored and so that 60%+ of the economy fails to grow.
The ominous crack that is appearing is that with 25% of the tax take already required to pay the (absurdly low) JGB interest cost, the country cannot afford the demographic change that is going to almost certainly bring down the tax take. Some things are estimates, subject to debate, but demography isn't one of those things

Nov 15 10:06 PM

[dieuwer:]

As long as there is a willing BOJ, prices of JGBs can stay elevated. In principle, the BOJ could announce that they will buy unlimited quantities of JGBs at par for eternity.
Therefore, it is not the price or yield of JGBs that is important, but the purchasing power of JGBs.

Nov 16 03:42 PM