In today's Money Thoughts, and in The Economic Clock™ update for Japan (sub. req.), we express concern about Japan's politics. We found it tough to recommend a "buy" on the market when there is no national leadersip: the opposition won the Upper House last July, the Prime Minister resigned last Wednesday, and the "ruling" party is riddled with divisiveness and rumours of scandals...nobody is in charge.
Add to this another political change: next March, the Governor of the Bank of Japan, the BoJ, will resign. At this stage we do not know when next year Japan's General Election will be, so assume that 2008 will be a political "double header," as they say in American baseball.
So there is turmoil in Japan's political tatami rooms. Let's peek behind the curtains for a moment, focusing particularly on the market implication of a leadership change at the Bank of Japan.
1. Mr. Abe's resignation means little fundamentally
In today's Money Thoughts we argued that even if Mr. Abe has resigned, his replacement won't be able structurally to solve anything. View the Japanese political house as one riddled with termites:
- the opposition rules the Upper House - regardless of who wins the LDP's Premiership;
- the ruling party remains riddled with scandals - regardless of is the next LDP Prime Minister, and
- the ruling party must remain fixated on restoring Japan's international glory - as opposed to the LDP earnestly addressing the concerns of the population at large, such as pensions and health care reform.
Thus, don't expect any market bonanza once the new Prime Minister has been announced: much of the sameness must prevail.
2. Market implications of Mr. Fukui's replacement at the Bank of Japan
The wonderful Financial Times of 12th September ran a story, "A policy vacancy" on this. My interpretation is this:
- The opposition Democratic Party of Japan [DPJ] has veto power over the next governor. This is becauset the DPJ won the Upper House in this July's election, and any vote on the Governor is won by a simple majortity.
- Encouragingly, the DPJ wants the BoJ to be
- more independent, and
- more hawkish on inflation
- This implies that the next BoJ Governor is going to have a freer hand. "Free from whom?" you may ask. "Free from the clutches of the Ministry of Finance, who traditionally have had the final say in who becomes BoJ Governor."
- Thus, my view is that once the new BoJ Governor is elected next March, he will raise Japanese interest rates strongly - to the "neutral" 2-2.5% level advocated by economists. This is the rate tnat "...is neither accomodative nor restrictive when the economy is growing at trend." This if from said FT article and I have used the italics.
- "At trend", however, is a growth rate that Japan will not see for a long time. Japan will keep growng below trend because of demographics and poor politcal leadership. Thus, there is the very real risk of "overshoot" - of the new BoJ Governor raising rates too quickly and thus killing any growth.
3. How to make money off this
Buy Yen for now: unwinding of carr9y trades, with Northern Rock plc having morphed into "Southern Gravel"
- Always speak with your financial advisor first!
- Long yen. Go long the yen for two reasons:
- First, yen carry trades will keep getting unwound. In America, Countrywide Financial Corp has moved to "Corpse", and in England just recently, the bank "Northern Rock PLC" morphed into "Southern Gravel". People are getting increasingly risk-averse, and thus will want to buy back the yen that they previously had sold in order to invest in purportedly higher-yielding assets, and
- If I am correct in assuming significantly "higher" Japanese interest rates, then watch the yen differentlal to (falling) US dollar rates narrow, making the yen more attractive.
- Long property, So what do you do with your yen? As we keep saying: do NOT enter the stock market. But, according to the South China Morning Post of 12th September, have a look at Japanese property funds: capitalisation rates (the ratio of income over a building's value) have bottomed at 3% and could very well rise with increased property demand. The reason for this has more to do with supply than demand. One Morgan Stanley Real Estate Director, Anand Madduri, reckons that annual supply of office stock will rise by only 6%-7% - implying rentals rsing by 8% - 10% over the next three years. So, even the BoJ raises rates to 2.5%, you still would be making about threefold by investing in property - not to forget yen appreciation on top of this for US dollar investors!.
4. How to save Money off this idea
Short stocks. However, I remain an adamant bear on the Japanese market: we have brayed about this for a long time in The Economic Clock™ for Japan. And if the BoJ tightens too fast, watch Japan go into another massive economic slowdown - one that will not make earnings flourish!
