“Don’t worry about hitting or missing. When you know it’s the right thing to do, whatever the crowd is saying, just shoot. That’s the winning formula.”
John Percival, The Way of the Dollar
If you are bearish on Japanese stocks, you should be bullish on the yen
Is the Japanese stock market telling us anything? Could it be that concerns are growing as to whether Prime Minister Abe’s three arrow strategy will be successful or not?
I think so.
USD/JPY versus Nikkei 225 Stock Index Daily:
There is evidence piling up to suggest failure is a real possibility. If that is the case, it would make a lot of sense to own the yen, with the caveat of course the yen maintains its tight correlation with Japanese stocks (as you can see in the chart above).
No doubt, the tight correlation could break down at any time for any reason. But I think the primary threat to this correlation is real crisis in the Japanese government bond market (JGB’s). If JGB’s finally get hit as investors and analysts and traders and financial writers and the tooth fairy have been anticipating since around 1994, we’d likely see the triple-whammy—a run out of stocks, bonds, and the currency. But for now, the repatriation game of weaker stocks and strong currency is very much still in play.
So far, two of Prime Minister Abe’s arrows have hit the target. The first arrow was aimed at the Bank of Japan; the goal to trigger an unprecedented campaign of monetary easing. The second arrow was also true to the mark, continued deficit spending on public works. The third arrow is arguably the most important. Its objective is to stimulate private sector-investment growth; and meant to be transformative and “normalize” the Japanese economy; it’s in the air but turbulence is growing.
In an interesting blog post by Andrew Smithers, appearing the Financial Times last week, he says the third arrow is aimed at the wrong target—Japan already invests “too much,” says Smithers. And if Abe is successful in generating more private investment, it could be the mother of unintended consequences and roil the Japanese bond market in a big way.
According to Smithers, “the return on capital in Japan is extremely bad” (by far the worst among the G-5 countries) and this is why investment has been falling and “needs to fall further.” Thus, the third arrow strategy, which at its core is about the government convincing business to invest more, is “absurd and doomed to failure,” he says.
There are many moving parts in play in Japan. For now, I’m cautiously short $-yen and cognizant of what another round of massive easing by the BOJ, in an attempt to overwhelm the possible negative feedback from the upcoming tax hike in Japan is a real possibility, might have on the pair.