Japanese Prefecture Debt, Overpriced Nikkei, and GDP Bonsai
February 16, 2015
“Real danger is nothing more than just living. Of course, living is merely the chaos of existence, but more than that it's a crazy mixed-up business of dismantling existence instant by instant to the point where the original chaos is restored, and taking strength from the uncertainty and the fear that chaos brings to re-create existence instant by instant. You won't find another job as dangerous as that. There isn't any fear in existence itself, or any uncertainty, but living creates it.”
―Yukio Mishima, The Sailor Who Fell from Grace with the Sea
The Q4 2014 Japan GDP print came in @ 2.2% annualized growth from the previous three-month period. Japan’s economy is now technically out of a recession. It is being parsed by some as a disappointment, which is fair enough. Consumption growth is weak, capital spending growth is flat, and income growth remains stagnant. The punch came from high exports. There is plenty underneath the headline that can be spun as a rationale for more hand-wringing, if that is what one is looking for.
The Nikkei opened higher in response, up 0.51% at the close. USDJPY declined. Some take these events as positive news supporting P&L. Some take it as a signal of more monetary stimulus coming—bad news in disguise.
The GDP print is a non-event, really. Maybe the real story is that crumbling of an out-dated ideology that believes progress is nothing more than people buying more and more super-sized crap.
The Nikkei jump doesn’t mean much. It is more a function of HFT bots throwing quotes against the wall than real money making an investment. Japan is one of the most advanced hosts of low-latency trading. The Tokyo Stock Exchange has Arrownet, the NYSE Tokyo liquidity Center and other technology companies that offer connectivity not only to Tokyo but other exchanges in Asia – drawing in investors outside Asia to trade there. Through Metabit, Japanese markets offers electronic trading access to all of Asia’s 14 DMA markets, including Japan, Hong Kong, China, Taiwan, Singapore, Korea, Australia, New Zealand, India, Indonesia, Malaysia, Thailand, the Philippines and Indonesia. This is sexy and flashy as these emerging Asia markets have high growth potentials. It plays into the global-economy’s-center-of-gravity-is-moving-east storyline.
It doesn’t mean anything apocalyptic, either. For literally decades, doomers have been weaving tales of untergang about this country. The combination of indebtedness and demographics lead inevitably to negative current accounts and diminished savings rates. Endgame totally しょうじょう.
If only all nations could age so well. Debt markets tell me an entirely different story where Japanese households and society are doing fine. Just look at agencies and prefecture bond yields.
There is, of course an alternative explanation: the Japanese art of downsizing. It is summed up beautifully in a piece carried by the NY Times called “Japan and the Ancient Art of Shrugging” by Norihiro Kato. In it you find a portrayal of Japanese youth being careful, frugal, and thoughtful about the future. Not carried away by excess and just not interested in cult of buying crap. As a result, GDP can’t help but look anemic.
Here’s the jist:
Three years ago, I saw a television program about a new breed of youngster: the nonconsumer. Japanese in their late teens and early 20s, it said, did not have cars. They didn’t drink alcohol. They didn’t spend Christmas Eve with their boyfriends or girlfriends at fancy hotels downtown the way earlier generations did. I have taught many students who fit this mold. They work hard at part-time jobs, spend hours at McDonald’s sipping cheap coffee, eat fast food lunches at Yoshinoya. They save their money for the future.
These are the Japanese who came of age after the bubble, never having known Japan as a flourishing economy. They are accustomed to being frugal. Today’s youths, living in a society older than any in the world, are the first since the late 19th century to feel so uneasy about the future.
I saw young Japanese in Paris, of course, vacationing or studying, but statistics show that they don’t travel the way we used to. Young people have grown less interested in studying foreign languages. They seem not to feel the urge to grow outward. Look, they say, Japan is a small country. And we’re O.K. with small.
It is, perhaps, a sort of maturity.
The rest of the world’s population is still exploding, and we are coming to see the limits of our resources. The age of “right shoulder up” is over. Japan doesn’t need to be No. 2 in the world, or No. 5 or 15. It’s time to look to more important things, to think more about the environment and about people less lucky than ourselves. To learn about organic farming. Or not. Maybe you’re busy enough just living your life. That, the new maturity says, is still cooler than right shoulder up.
They won’t change. They are too settled in an earlier stage of development, in a dream of limitless growth. But society matures around them.
Japan remembers what it is like to be old, to be quiet, to turn inward.
That is a compelling story, a story that fits the facts. Japan is not a country of old dis-savers colliding with young profligates ending up with no money to go around for anybody. You know, the Kyle Bass lunacy. Instead you see diminished loan demand, balance sheet conservatism, and a thoughtful view about what matters from the experienced elderly and a surprisingly worldly-wise youth: a good explanation for low yield to maturity and equally low defaults.
I have no doubt that some lucky pot-head is going score enormous cash on shorting JGBs one day, but just plain dumb luck will be the only reason. That is just markets. They make fools of the wise and fools one-hit heroes. Scoring on that is like waiting on that giant meteor to create a minor apocalypse. JGBs and debt markets in general look like the knit well here. The odd man out is the Nikkei.
Markets are telling me that the Nikkei is not cheap and because of this I would prefer being higher up the capital structure. Have a look. Inflation expectations implied by the linker-JGB spread remain stubbornly negative. The relationship between the Nikkei400 (the broad market) and implied is clearly dislocated. Since when has deflation meant pricing power and higher profits for any business?
I think what you are seeing with the Nikkei is more of an historical impulsive. Hugh Hendry argued something to this effect when he began to think more flexibly about financial reality. He compared TOPIX to its 50 year average. Below I do the same for the Nikkei 225.
I see the same phenomenon as Hendry: a long spate of lurking around the average followed by an escape-velocity ramp courtesy of the BOJ. I’m convinced that this is merely transitory and that I can’t get comparable returns from risky debt. To argue otherwise is to argue that the capital structure of finance is in fundamental semi-permanent disconnect. That lenders will suffer while owners book consistent windfall gains. There is always a place of equities, but that is a little ridiculous.