Hard Lessons from Japan

“The world is awash with liquidity.”

-Anonymous Investor, circa late-2007


Conclusion: New proposed measures to stimulate the Japanese economy will result in nothing more than smoke, mirrors, and further economic stagnation. Further, taking a dive into Japanese corporate balance sheets and psyches reveal some interesting takeaways on where the U.S. may be headed.


Position: We remain bearish on Japanese equities for the intermediate-term TREND and are currently short the Japanese yen via the etf FXY.


Today Japan, the world’s leader in Big Government Intervention, reminded us of the long term consequences of trading away long-term, sustainable prosperity in exchange for short-term, levered growth. In addition, they reminded us just how hard it can be to wean ourselves off the fiscal and monetary stimulus drug that many investors recklessly clamor for.


This morning a panel led by Finance Minister Yoshihiko Noda unveiled a tax stimulus package that is designed to “increase hiring” and “spur economic growth”. The measures include: 

  • A to-be-determined corporate tax rate cut (latest rumor at 5%);
  • A ¥200,000 tax write-off per person for small firms that hire at least five people or increase their workforce by 10%; and
  • A 300bps tax rate reduction for compliant small businesses. 

Of course, with Japan struggling to contain the world’s largest public debt burden, there were compromises to help recoup the ¥1.4 to ¥2.1 trillion in proposed lost revenue: 

  • The government will cap income deductions for those earning in excess of ¥15 million annually;
  • Income deductions for corporate executives earning in excess of ¥40 million annually will be cut in half;
  • The minimum inheritance tax will rise +500bps to 55%; and
  • Levies on energy will increase as part of a broader environmental tax hike. 

Combined, these measures are supposed to promote growth and stimulate the economy. From our vantage point, it looks like Japan is merely robbing Peter to pay Paul – at best. As we have shown in our Japan’s Jugular slide deck, the Japanese economy has not responded well to a bevy of Keynesian stimulus measures over the years:


Hard Lessons from Japan - 1


Why has Japan not responded well? Pundits point to a multitude or reasons, including demographics, overcapacity and a weak property market. The single most important factor we highlight is the lack of business and consumer confidence resulting from nearly two decades of fear-mongering and government intervention.


In classic liquidity trap fashion, Japanese consumers have been reluctant to spend and borrow, banks have been reluctant to lend, and firms have been reluctant to invest (all on the margin, of course). Take Japanese corporation’s cash levels, for example; cash and equivalents at members of the Nikkei 225 climbed +8% this year to a record ¥1,309 ($15.60) per share. Further, companies cut bond sales 17% YoY even as corporate yields hit a five-year low earlier in the quarter.


The lack of interest in investing has been driven by weak domestic prospects for growth and a lack of favorable rates of return. Anecdotally, the comments of Kazuto Tsubouchi’s, the CFO of Japan’s largest mobile phone operator, NTT DoCoMo, should not be taken lightly:


“We have more cash than we need, but no growth investments… This is a great time to issue bonds and we would if we had no money.”


Apparently sitting on mounds of cash is not equivalent to finding and extracting an actual rate of return on that money. Keep that in mind the next time you hear the tired bullish argument that “companies are sitting on loads of cash and balance sheets are pristine”.


While we’d be remiss to refute either point (S&P 500 cash holdings have risen +10% YTD to $261.68 per share – the most since at least 1998), we are offering a contrarian view to the consensus belief that suddenly the world’s excess liquidity will magically translate into positive investment returns. If the Japanese experience is any guide, we’re likely to see more of the same cash hoarding by U.S. companies, as our burgeoning public debt north of 90%/GDP looks to structurally impair U.S. economic growth going forward.


Of course U.S. companies could follow Japan, China, and other cash rich nations into hunting for growth via emerging market acquisitions. Japan, for one, has increased its overseas investments by +18.3% over its full-year 2009 total of $22.9 billion.


As more and more corporations from slow-growth, developed economies look to buy growth via overseas transactions, expect the prices of those assets to be bid up. Emerging market assets will be overpaid for and “goodwill” will join “cash” as another bloated part of corporate balance sheets.


Lastly, we saw Japan’s Tankan Survey register its first drop since 1Q09 among large manufacturers and large non-manufacturers, coming in at 5 and 1, respectively. The 1Q11 forecasts point to outright negative sentiment in the range of (-1) to (-2).


Hard Lessons from Japan - 2


From a quantitative perspective, Japan's NIkkei 225 is bullish on both the TRADE and TREND durations, aided by recent yen weakness. We continue to caution investors that Japanese equities are setup for a sucker punch once the tide turns on equities as an asset class in early 1H11. We strongly recommend you don’t buy the storytelling associated with “Chinese acquisitions of Japanese firms” or yen weakness. Japanese exporter’s profits are likely to slow in 1H11 right alongside global growth – irrespective of the yen. 


Darius Dale



Hard Lessons from Japan - 3

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