- The yen should depreciate in value; however, there are not a lot of viable ways for the retail investor to profit from this.
- Inverse leveraged ETFs such as YCS under perform because of daily rebalancing.
- ETFs such as FXY are tricky because of sponsor fees.
A lot of investors today are vocal on being short the yen; however, we haven't come across a single retail investor that has provided a strong way to profit from the widow-maker prophecy. It's interesting to note because YouTube videos and chat rooms have people commenting on gloom scenarios, but why talk the talk if you're not going to profit from it? Bergdorf's doesn't accept street credit.
For those who may need a background as to why to short the yen in the first place, there are plenty sources online that can walk you through it. It's known by many as the Kyle Bass trade and you can watch his last video presentation online here. He talks about Japan from 6:52 to 16:20, but the rest of the presentation is informative as well.
To sum it up, Abenomics is trying to reach 2% inflation with 10-year JGBs trading around 60bp. No one is going to hold, let alone buy, an instrument where you're losing 140 bp in a 2% inflation environment. The Bank of Japan is the only buyer of JGBs and when they stepped away from the market in April, not a single bond traded for a day and a half. Should JGB rates rise to 200bp, Japan can't service its debt. With a current account structurally going negative and an aging population, it's not looking good for Japan.
The BOJ will need to increase their QE fairly soon, especially with announcements from Japan Post Bank and the GPIF that they will be rebalancing their portfolios out of JGBs. They will try to hold rates as stable as they can without officially pegging them, but nevertheless this is still extremely yen-weakening.
Upon requesting our brokers for a way to short the yen, we were provided with two ETFs: CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY) and ProShares UltraShort Yen ETF (NYSEARCA:YCS). At a first glance they seemed like they were good plausible ideas, but upon further inquiry we discovered structural problems with ETFs in general.
Briefly, with FXY the sponsor has the ability to close the fund at any time, and should the yen have a dramatic decline, the fund could be liquidated before the bad kind of inflation fully materializes. We inquired about it to the sponsor and didn't receive a word back, but they have closed funds tied to currencies before, and should the sponsor not be able to service the fees associated with the fund, we imagine they'd have an incentive to liquidate.
Also, YCS is tricky because it is a leveraged ETF and daily rebalancing is deceiving. If you look at returns over a period of time, the yen may weaken and YCS could still have declined in value. For more information on leveraged ETFs, we recommend reading this.
So with ETFs out of the way, what is a retail investor supposed to do? Well, there are more esoteric securities that one could buy; however, it requires the right broker and the experience required to get approved for trading. The best bet is to short a Japanese company with a lot of JGBs on their books, or whose main source of revenue is in yen, preferably both. We're not going to specifically name a company because there are plenty out there and they will all be affected. You can see companies getting rid of their JGBs by the increase in capex, so look for the companies that have been the least aggressive in their balance sheet management.
The purpose of this article was to give an update on Japan and to inform those who may have ETF positions that there are vulnerabilities in the products. We hope we reached a few readers before they become disappointed with their results so that they can adjust their positions accordingly. As always, we're happy to hear anyone else's views on the subject.