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Nikkei Nose Dive: Signals From A Week Japan
In mid August, just as the Nikkei began to falter, the "old guard" LDP (Liberal Democratic Party) turned in the keys, having lost the general election by a landslide, and now the contending DPJ (Democratic Party of Japan) finally has the reigns. The LDP had been in control during every year but one since the beginning of Japan's post-war government, and the DPJ has inherited more than a few liabilities.
Japan is facing unemployment that peaked at 5.7% in August and has since receded to 5.3% in the latest October reading, still historically high by Japanese standards. But what's really hurting Japan is the deflation problem, only recently admitted by the BOJ (Bank of Japan), which sites consumer prices excluding food at -2.3% yoy (year over year). The debt of the nation sits just shy of 200% of GDP in an era where dwindling numbers of offspring forewarn of a mass scale government revenue shortage. The National Institute of Population and Social Security Research predicts that current trends will force Japan to contend with a 30% population decrease by 2055 (less than 90 million people and roughly equal to the 1955 tally) where the number of citizens under the age of 65 will fall in half.
So has Japan's stock market fallen because it's currency has declined since August, causing for the opposite effect that the dollar is having on U.S. equities? One of my favorite professors described it best saying, "as it turns out... maybe". In the chart below you'll see that the Japanese Yen turned more expensive relative to the dollar early in August, but so did every major currency included in the above chart citing national equity index performances. After all, the Japanese Yen was the big brother to the Dollar as a preferred carry trade currency and was used to fund a plethora of risky bets under previous LDP low interest rate policies.
The new JDP administration is walking into a shrinking population, deflationary currency environment, historically high unemployment, 200% x GDP debt, 3% GDP stimulus spending and only 1.2% growth in the third quarter to show for it thus far. It must be increasingly uncomfortable for Japanese Prime Minister Hatoyama and rightly excruciating for BOJ Governor Shirakawa. The prime minister is promising a boost of costly public services, handouts and tax cuts to the struggling consumer base while Shirakawa vows to keep rates low when speaking to the G20.
Investors are exiting Japanese stocks because as things stand the Japanese government won't make good on debts and the only reasonable outcome will be for Japanese stimulus to be withdrawn early. In the alternative situation, Japan default on debts and create extreme problems for the nation and Japanese corporations in the future. Some blame the threat of deflation amidst global asset appreciation for the Nikkei's recent misfortune, yet the truth of the matter shows an indebted nation spending more and making less in an environment where global recovery is not a strong enough sell to stay long firms headquartered therein.
While U.S. regulators see what is unfolding in Japan, a blind eye is turned and the wallet comes out. After all America is a nation of winners, where the adverse scenario to the stimulus not working before our own debts come due is just too dark for a "#1 Nation" to acknowledge.
Disclosure: Long SDS, Long TYO
Nikkei Nose Dive: Signals From A Week Japan
In mid August, just as the Nikkei began to falter, the "old guard" LDP (Liberal Democratic Party) turned in the keys, having lost the general election by a landslide, and now the contending DPJ (Democratic Party of Japan) finally has the reigns. The LDP had been in control during every year but one since the beginning of Japan's post-war government, and the DPJ has inherited more than a few liabilities.
Japan is facing unemployment that peaked at 5.7% in August and has since receded to 5.3% in the latest October reading, still historically high by Japanese standards. But what's really hurting Japan is the deflation problem, only recently admitted by the BOJ (Bank of Japan), which sites consumer prices excluding food at -2.3% yoy (year over year). The debt of the nation sits just shy of 200% of GDP in an era where dwindling numbers of offspring forewarn of a mass scale government revenue shortage. The National Institute of Population and Social Security Research predicts that current trends will force Japan to contend with a 30% population decrease by 2055 (less than 90 million people and roughly equal to the 1955 tally) where the number of citizens under the age of 65 will fall in half.
So has Japan's stock market fallen because it's currency has declined since August, causing for the opposite effect that the dollar is having on U.S. equities? One of my favorite professors described it best saying, "as it turns out... maybe". In the chart below you'll see that the Japanese Yen turned more expensive relative to the dollar early in August, but so did every major currency included in the above chart citing national equity index performances. After all, the Japanese Yen was the big brother to the Dollar as a preferred carry trade currency and was used to fund a plethora of risky bets under previous LDP low interest rate policies.
The new JDP administration is walking into a shrinking population, deflationary currency environment, historically high unemployment, 200% x GDP debt, 3% GDP stimulus spending and only 1.2% growth in the third quarter to show for it thus far. It must be increasingly uncomfortable for Japanese Prime Minister Hatoyama and rightly excruciating for BOJ Governor Shirakawa. The prime minister is promising a boost of costly public services, handouts and tax cuts to the struggling consumer base while Shirakawa vows to keep rates low when speaking to the G20.
Investors are exiting Japanese stocks because as things stand the Japanese government won't make good on debts and the only reasonable outcome will be for Japanese stimulus to be withdrawn early. In the alternative situation, Japan default on debts and create extreme problems for the nation and Japanese corporations in the future. Some blame the threat of deflation amidst global asset appreciation for the Nikkei's recent misfortune, yet the truth of the matter shows an indebted nation spending more and making less in an environment where global recovery is not a strong enough sell to stay long firms headquartered therein.
While U.S. regulators see what is unfolding in Japan, a blind eye is turned and the wallet comes out. After all America is a nation of winners, where the adverse scenario to the stimulus not working before our own debts come due is just too dark for a "#1 Nation" to acknowledge.
Disclosure: Long SDS, Long TYO
Bernanke's Mandate, A Contradiction
Bernanke's Mandate
The Fed Chairman went one step further to assure the audience at the Economic Club of New York that his board of governors would "continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability."The Fed's Choices
While the Economic Club might have bought it, the mandate is nothing short of contradictory and insults the intelligence of the market. Regardless of the billions of dollars the Fed extends or withdraws from the GSE's, the passionate Bernanke yarns of dollar strength, and Obama-talk about the importance of jobs, the Fed has these simple two options... keep the Fed Funds at 0% or raise it.
0% Fed Funds Rate
If the Fed keeps the rate at 0% the U.S. economy may see a peak in the headline unemployment number sometime in mid 2010, thus addressing the jobs end of Bernanke's mandate, but not without triggering asset appreciation all across the world. This was a successful exit strategy to the prior recession in the U.S., allowing businesses to invest at cheap rates and create jobs for consumers to invest back in the appreciating assets (homes). However 0% rates are currently only allowing institutional investors and governments to borrow funds, who have then invested them in risky assets such as U.S. Equities, Commodities and Emerging Markets. This carry trade continues to devalue the U.S. dollar and decreases the purchasing power of strapped U.S. consumers.
This time businesses can't secure financing from banks because their balance sheets remain in shambles, prospects for earnings growth are dwindling, and consumers continue to lose their jobs. Data out this week showed Q3 2009 posted a record 6.25% of total U.S. mortgage holders in delinquency, proving that 0% Fed Funds rates offer no comfort to those who need it.
Quantitative Tightening (QT)
QT is an option and should be realistically considered as the only alternative to severe long term inflation. Critics of this view will cite the PPI (Producers Price Index) core statistic's decline of -0.6% in October as evidence to support a deflationary or neutral environment, yet the true effects of artificially inflated commodity prices won't be felt by consumers for some time. Contrarily, the report showed crude goods prices increased by 5.4% over the same period. Should interest rates remain low long enough to increase already inflated asset prices and consumers remain jobless, the result will be a pinched supply chain. Input prices will continue to rise as output prices stagnate or fall and companies/workers go out of business.
The only responsible option for the Fed is to begin QT now and take whatever pain comes along with it. Australia has already begun raising its Fed Funds target and will soon be followed by others, yet Bernanke reaffirms and extends his window of 0% rates until mid next year or later. Meanwhile the charade of talking up the Dollar and failing efforts to lure China into de-pegging the Renminbi amidst a Sino-recovery founded on the cheap currency.
Talk is cheap Mr. Bernanke and so is the Dollar. Keep the USD from falling further by raising rates and weathering the potential short term pain. Many may hate you in the short run and equity markets may turn south, but we will avoid a decade of stagnation, emerging stronger and faster because of it.
Disclosure: Long TYO
Standing on The Pivot: The Past and Future U.S. Economy In Terms of Housing
Inevitably even the grizzlies have been watching economic indicators gauging the housing market "recovery", as talk of a 2009 rebound in the United States has now been confirmed by 3.5% growth in the third quarter. Existing home sales bottoming, construction spending pulsing and extreme incentives for new buyers have sweetened the potential for a repeat of the 2004 housing recovery we all loved so well. Yet there remains the issue of magnitude, regarding a potential housing recovery, which may contrast that of 2004 a great deal, and could kill the lasting effects of a bottomed housing market on the broader economy. We will attempt to review and assess the American economy by result of the Housing Market from a historical and quantitative standpoint.
Price To Earnings
Twenty four months spanned between the peak 6.5% Federal Funds Rate mid summer 2000 and the screeching halt to 1% in December 2003, where rates would would hover through Independence Day of the following year. Prior to new millennium S&P 500 P/Es in the forties and the ensuing share price slashing, one must scroll back to 1961 to sight a Fed Funds Target below 2% and further to 1954 to find the over night rate below 1%. Similarly, we forget that prior to 1995 the S&P 500 last carried a P/E ratio greater than 25 in 1930, yet this fundamental statistic remained above 20 for the duration of the previous recession and until October of 2008.
More »U.S. and U.K. Face Trouble: Weakening Currencies and Stagnant Economies Weigh on Investors
Banks are now fearing the probable need for further equity offerings that will come to pass in the near future. British and American bankers both face a real danger as equity prices become less and less attractive given the simultaneous declines of the currency in which shares are held. Over the past 200 days the S&P 500, the per ounce price for gold, and the WTI continuous spot price for crude oil have increased by 25%, 30%, and 80% respectively, while the US Dollar index fell by 10%. The three assets increased by varying degrees of intensity, responding congruently to market moving news throughout the period following the March 9th lows, while the dollar's value changed with a negative correlation.
According to the chart, it were the commodities who outperformed the US equity market since the March 9, 2009 low of 666 for the S&P 500. Then, why should foreign investors risk allocating funds to U.S. corporations bearing 20+ P/E valuations and an increasingly jobless consumer base. It instead likely that they will avoid such risky assets as U.S. stocks, where the average price appreciation over the past 200 days is halved after accounting for the drop in the value of the dollar.
On top of these inflationary pressures, equities in the U.S. and Britain will most likely begin to depreciate as firms, not limited to the aforementioned banks, including U.S. Tarp recipients such as Bank of America and Citi Group find ways to raise additional capital needed by breaking off business arms and issuing more shares. It is the increasing share issuance, occurring as companies squirm for much needed capital, which will dilute shares in the coming months.
Finally, the dollar will likely continue it's inverse stickiness to equities as commodities maintain a direct correlation for a period of time following the imminent pullback in equity prices around the globe. The absence of stimulus and optimistic guidance for the next few quarters amidst rude reports of struggling economic activity will pull down all asset classes along with commodities. But should equities fall through one or more levels of resistance and begin to change the tone from one of hope to one of fear, commodities will break free from the current trend and spike upwards as the dollar begins to fall due to a mix of inflation and the retreating consumer.
The U.S. Fed, Treasury, and White House have made it brutally apparent that they will not take "no recovery" for an answer and will continue pumping money into the system by whatever means necessary. Yet there will come a time when the global appetite for U.S. debt will curb and the pressures of inflation will truly be felt. This time will be signaled by the market and will become apparent when equity markets fall on news of further stimulus spending. It appears that yields on long term treasury debt are already beginning to rise as the $300 billion Fed purchase program of such Long-Term U.S. paper has ceased, and may cause real interest rates on long term U.S. debt to increase. Unfortunately, such a decrease in demand for U.S. Debt would exacerbate the ill effects that a widening U.S. current account deficit will have on the dollar. A growing current account deficit had been largely responsible for the falling U.S. Dollar index from 2002 through 2006 that, despite it's narrow levels not seen since 1991 at 2.8% of GDP, will ultimately trend wider.
The weak dollar has most recently been fueled by the widespread dollar borrowing to fund "carry trade" investments, where the expectations for a near zero Fed Funds rate to remain low hurt the value of the dollar. The Fed went public on Wednesday, practically guaranteeing a 0% Fed Funds rate amidst Treasury admissions of probable long term debt yields rising. However, fundamental headwinds facing the U.S. currency described above will ultimately outweigh waining carry trade borrowing to drive the value lower.
Note, there need not be a specific date on which the U.S. physically begins quantitative tightening for the carry trade driver to wear out. The realization that riskier investments funded by the short dollar play are no longer feasible can equally drain the pool once enough game has come to drink. After a short rise in USD value and a drop in commodities, the Dollar will continue to decline. Equities have little room to appreciate.
Disclosure: No Positions
Profit From Weak U.S. Balance Sheet, Short the 10-Yr Treasury Note
It's plainly evident that the 10 Year U.S. Treasury Note yield increased into the early 1980s near the point where mortgage rates peaked at 18.45% for a 30 year fixed rate product, in October 1982, and the "S&L (Savings & Loan Bank) Crisis" began. Since the 1981 high yield of 15.84%, the 10 Year U.S. Note has neared the point of zero amidst accelerating deficit spending over the past decade.
The U.S. yield curve, based in a soppy overnight rate at 0%, has been tamed by Ben Bernanke's $300 billion program to buy 10+ year Treasury obligations and the less public Federal Reserve purchases of "toxic assets" from the GSE's and Government owned banks (Citi and Bank of America). Recent decisions to remove these two methods of backstopping American finance will effectively release the long end of the yield curve out into the wild. Interestingly, the Fed concluded to remove these measures amidst a climate of stagnation in economic activity and talks of further stimulus on Capital Hill, both headwinds to the perceived solvency of the U.S. government.
The strategy of shorting U.S. Treasury Debt is the only strategy that makes you money over the medium term irregardless of nearly every possible economic outcome. Should the economy recover and the Federal Reserve begin quantitative tightening by raising short term rates, long term rates will also rise as demand will fall for government debt replaced by riskier assets. If the economy turns back into contraction and stocks fall, demand for treasuries may spike temporarily but the bid to cover ratios in current auctions already signal un-sustainably high demand and will only drive yields lower for a very short time. As the economy weakens and stocks continue to fall , investors will pull out of U.S. government bonds due to fears of revenue destruction and insolvency. In the contraction scenario, there will be no desire to lend to the debt heavy U.S. government as Uncle Sam's AAA credit rating is again called into question.
The final risk to this strategy identifies the recently narrowed U.S. trade deficit, which had contributed to the steadily increasing demand for long term U.S. debt since 1982. Surplus dollars received under more unequal trade levels by foreign counterparts were invested almost completely in American bonds, thus driving the yields continuously lower and further perpetuating the American consumption that was fueling the deficit growth in the first place. This however is the final bubble which has yet to burst that will finally cleanse the over-leveraged consumption by the developed world, having followed the lead of the United States. In the unlikely event that U.S. consumption returns and trade deficits resume, trade partners have already shown their desire to hold tangible assets, signaled yesterday by India's trade of 6.7 billion USD for 200 tonnes of Gold (7% of the world's annual gold mine production). It is therefore our view that any "risk" of a resumption to the previous norm of global trade inequalities is counterintuitive and that growing imbalances with India and China will discourage policies to bloat their surplussed coffers with the final toxic asset... U.S. Government Debt.
To implement this strategy it is easiest to simply buy the Direxion Daily 10-Yr Treasury Bear 3X Shares ETF (TYO). This ETF gives you enough leverage (3X) to profit from the relatively minor swings in Treasury Yields and is much safer than actually shorting the U.S. 10 Year Note, because your losses are limited to the initial investment made. Make note, this fund will fluctuate directly proportional to the yield on the 10-Yr Treasury Note and inversely to the price.
Disclosure: Long TYO