There is an ever-increasing level of doubt that Abemonics will help Japan escape its “lost decade,” writes John Nyaradi of Wall Street Sector Selector, and significant profit opportunities could be available as Japan’s crisis deepens.
Japan’s economic travails over the last 20 years have been well documented. As a result, Prime Minister Shinzo Abe is trying to revive the country’s flagging economy with what has become known as “Abenomics.”
Abenomics is based on a plan which consists of “three arrows”: reflation, government spending, and a strategy of “reforms” (many of which have yet to be disclosed) intended to spur growth. Deflation has been a constant problem for Japan as GDP has remained dismal and the stock market is still far off its highs of twenty years ago.
The plan had an impressive roll-out. In December of 2012, the Nikkei 225 Stock Average (EWJ) began to rally hard. By mid-May of 2013, the Nikkei was had advanced more than 50% since the first of the year. Japan also enjoyed increased consumer spending as the policy appeared to be working and finally—perhaps—re-inflating the asset bubble that popped 20 years ago. As they say: “The road to hell is paved with good intentions.” The intentions for Abenomics are for GDP to grow and the yen (FXY) to weaken. Unfortunately, those good intentions have led Japan into a liquidity trap as Abenomics is forecast to increase Japan’s debt to more than 240% of GDP in 2013, the highest of any developed nation.
In late May of 2013, Abenomics encountered more than a few headwinds and markets have become less enchanted with the agenda. Things have taken a turn for the worse since Abenomics hit rough water at that point.
After climbing as high as 15,627 on May 22, the Nikkei 225 Stock Average (EWJ) has plunged nearly 15%. The Japanese yen has fallen in excess of 20% since its recent high in September of 2012. Japanese government bonds (JGBs) have been taking a wild ride as markets lose confidence in Abenomics, with yields on the 10-year note spiking from 0.315% in April to 0.88% in mid-June.
The impact from these developments can be felt beyond Japan. Japan’s bond market is the world’s second largest, its economy the third largest, and Japan is the fourth largest trading partner of the United States. American investors and hedge funds have exposure to JGBs, and we may eventually learn from the FDIC that a number of American banks held JGBs.
Regardless of whether Abenomics ever works for Japan, investors have several alternatives available to make Japan’s problems work to their own advantage.
Professional investors see opportunities on the short side of the Japanese trade, although we may eventually see the Japanese Central Bank muster the will to avoid defeat. The question of whether that will ever happen will be pivotal to one’s strategy for investing in the long or the short side of the trade.
Long Japan trades include going long Japanese equities (EWJ), long the Japanese yen (FXY), or long Japanese bonds (JGBT).
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Short trades on Japan include shorting the Japanese yen (YCS), shorting the equity market (EWJ), or shorting the bond market (JGBS).
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Bottom line: Abenomics is a bold, some would say desperate, plan to revive the sinking Japanese economy and now it seems to have hit the shoals as global financial markets lose confidence in the program. Japan has dug itself a deep hole of debt from which it will be very difficult, if not impossible, to escape. Worse yet, demographics are also working against the country as the population ages and death rates outnumber births by a significant margin. On the bright side, significant profit opportunities could be available to knowledgeable investors as Japan’s crisis deepens. For now, probability seems to favor bets against success for Japan.
By John Nyaradi, Publisher, Wall Street Sector Selector
