Japan’s Jugular Update

Conclusion: Below we revisit our intermediate and long term theses on Japanese assets – the both of which are decidedly bearish.

 

Position: Short Japanese equities via the etf EWJ.

 

Earlier this morning, we opened a short position in Japanese equities in the Hedgeye Virtual Portfolio. At current prices and overly bullish sentiment, the short idea looks much better than it did on October 5th, when we introduced our Japan’s Jugular thesis. For the sake of an easy refresher, we’ve updated the presentation and added a few more slides to reflect the current setup: http://docs.hedgeye.com/Japan's%20Jugular.pdf

 

As a quick reminder, the Japan’s Jugular thesis is two-fold in duration:

 

Intermediate-term TREND (Bearish on Japanese equities):

  • The benefit derived from yen weakness is vastly overplayed, setting up for an asymmetric risk/reward opportunity on the short side as consensus underestimates the weak yen’s impact on corporate profitability via higher input costs;
  • Slowing growth abroad – particularly in emerging markets – will crimp Japanese export and manufacturing growth, which will result in higher unemployment;
  • Slowing consumption growth in the US creates an even higher asymmetric risk/reward setup for Japanese export growth that “no one will have seen coming”; and
  • Consumption growth in Japan (~60% of the economy) is rolling over as higher prices on the margin diminish demand and confidence remains depressed. 

Long-term TAIL (Bearish on the Japanese yen; Bullish on Japan's CDS):

  • A rapidly aging and declining population will continue to weigh on growth and Japan lacks the domestic savings and foreign capital to invest in its long term potential output;
  • Demographics, regulatory uncertainty, and a favorable cultural mindset towards entitlements will make it impossible to radically rein in entitlement spending and retirement benefits, which will render both the Japanese government and Japanese pension funds insolvent.
  • Waning domestic and global demand for JGBs will force the BOJ to do a lot more of what Paul Krugman suggested they do back in ’97: PRINT LOTS OF MONEY to finance debt issuance and keep rising borrowing costs from crushing the economy. QE2 pales in comparison to the amount of fiat money-printing the BOJ will have to do to “comprehensively ease” over the next decade. 

We intend to trade around our exposure to Japanese equities, understanding full well that the EWJ will minimize gains as the yen is likely to appreciate near-term vs. the $USD (we’re short UUP as well). That said, our research from both a fundamental and quantitative perspective suggests Japanese equities are a good short here.

 

Darius Dale

Analyst


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