The Economic Data calendar for the week of the 28th of March through the 1st of April is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
Conclusion: Buying the dip in advance of the recovery story in Japan is as consensus as buying the top in Japanese equities was in February. Don’t be pulled into this value trap. Further, we use historical data to show how current Japanese monetary and fiscal policy may have Japan en route to 1930’s-40’s-style stagflation.
This morning, it was confirmed that foreign investors bought a net ¥955B ($11.8B) worth of Japanese equities last week – the most since 2004 – as “buy the dip” took on a whole new meaning. In comparing the week ended March 18th to similar weekly data, Japan’s Ministry of Finance confirmed that this is “substantially the most on record”.
In conjunction with the report, we also received more confirmation that the “flows” indeed drove the Nikkei 225 to its latest lower-high on February 21st, as foreign institutional investors were weekly net buyers of Japanese equities from Oct. 29 through Mar. 18 – the longest streak since the 26 weeks through Dec. 9, 2005. That’s not at all insignificant, as roughly 70% of the trading volume in Japan is the result of foreign institutional transactions – likely because most Japanese aren’t gullible enough to buy their own equities after two decades of lower-highs and lower-lows.
The comments provided by Richland Capital Management’s Alex Au to bloomberg.com support our view that foreign investors have been and continue to plow money into Japanese equities because they are “cheap”:
“Foreigners are probably not necessarily bullish, but are thinking they can buy some cheap stocks at that moment.”
Given that foreign investors have been net buyers since October, the phrase “doubling-down” certainly comes to mind.
Switching gears, our bearish thesis on the Japanese economy hasn’t changed since early October. If anything, the accompanying sovereign debt issuance acceleration resulting from the reconstruction costs (upwards of ¥25 TRILLION or $308.6B) further depresses Japan’s long-term growth prospects. Empirical studies have shown sovereign debt buildup past the Rubicon of 90% Debt/GDP structurally impairs an economy’s long-term growth prospects, and Japan, with its ~210% ratio, has been no exception.
Given the last eight centuries of history’s lessons, the following questions should be considered:
Regarding duration, anyone who’s in it for the long haul needs a refresher on history’s lessons, which indeed show us that buying and holding Japanese equities has been arguably the worst trade of the last twenty years.
Regarding growth, we’re almost certain the Keynesian Kingdom will find a way to pull-forward future demand to help finance this earthquake. We caution, however, that merely REPLACING what has been LOST due to the recent tragedy with unprecedented levels of government leverage is NOT growth. Using earthquakes, tsunamis, and nuclear meltdowns as catalysts on the long side are not investment processes we subscribe to at Hedgeye.
Regarding inflation, we got some positive news this morning that Bank of Japan Governor Masaaki Shirakawa is opposed to monetizing the aforementioned recovery-related sovereign debt issuance, out of fear it may stoke inflationary pressures. This is in stark contrast to the recent proposals out of the DPJ and LDP calling for the BOJ to monetize the incremental debt issuance, out of fear the additional supply wouldn’t be adequately absorbed by the market – i.e. the bureaucrats fear a higher cost of capital looms in Japan’s near future if more and more JGB supply hits the open market (exactly what the long-term component of our Japan’s Jugular thesis forecasts).
Currently, the BOJ limits itself to purchasing long-term JGB debt on the secondary market consistent with the amount of banknotes in circulation, meaning that the BOJ has "spare capacity" to purchase around ¥20 TRILLION yen to purchase long-term JGBs – on top of its current purchases of ¥21.6 TRILLION annually and its current Asset Purchase Facility, in which it is buying ¥5 TRILLION of short-term JGBs. The issue with the current political proposals lies in the fact that the BOJ is reluctant to outright monetize the government’s debt by funding it on the primary market.
In spite of Shirakawa’s warnings about the inflationary impact of debt monetization, as well as the potential blow to Japan’s international credibility, Japanese legislators have pushed on, invoking parallels to the Great Depression – the last time the Japanese government used a special circumstance to justify funding a substantial increase in debt and deficit spending via BOJ debt monetization:
“Bank of Japan bond underwriting is a policy that is evaluated highly worldwide because it helped Japan recover from the Great Depression before others.” – DPJ member Yoichi Kaneko
“If this isn’t a special situation, what is?” – LDP member Kozo Yamamoto
Shirakawa aptly responded:
“If a central bank starts to underwrite government bonds, there may be no problems at first, but it would lead to a limitless expansion of currency issuance, spur sharp inflation and yield a big blow to people’s lives and the economy, as has happened in the past.”
As a recap, in 1932, Japanese Finance Minister Korekiyo Takahashi boosted spending by 34% with the aid of BOJ monetization, which peaked a year later at 89.6% of JGB issuance and continued for the next 14 years until the end of WWII. Takahashi was later assassinated in 1936 when tried to rein in these expansionary policies to fight inflation. It appears that even 80 years ago, those that get paid by The Inflation don’t like it when the government pulls the plug any more than they do today…
All told, if Japan is to avoid the structural stagflationary problems that persisted throughout the 1930’s and 1940’s whereby consumer and producer prices eventually grew at YoY growth rates north of +40% and real GDP growth slowed sequentially for nearly 15 years, the bureaucrats would be well-served to heed Shirakawa’s warning. Unfortunately, with the yen trading down on the day in spite of the BOJ’s sobering comments, we, alongside the global currency market doubt they will.
Keith McCullough ’99 and Daryl Jones ’98 (both members of the 1998 NCAA hockey team) will be hosting a tailgate party at their offices in New Haven on March 25th starting at 1pm in advance of the NCAA games in Bridgeport. Their office is located at 111 Whitney Avenue, which is between Trumbull and Bradley. This the Taft Mansion, and the name of their company is Hedgeye Risk Management, which is on the façade of the building. Keith and Daryl would like to invite all members of the Yale Athletic Community to this event.
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.
Notable news items/price action over the last twenty-four hours.
This note was originally published at 8am on March 22, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I ribbed Ben for wearing tan socks with a dark suit.”
-George W. Bush, "Decision Points"
I finished reading President George W. Bush’s “Decision Points” yesterday. He ends his biography with a chapter titled “Financial Crisis” – and I’ll start this morning’s Early Look re-thinking the same.
Newsflash: the most recent “Financial Crisis” that Big Government Interventionists perpetuated before they allegedly came to our rescue is long gone. There’s always a crisis somewhere, and I can guarantee you that we’ll have another one in Global Macro markets as soon as consensus concludes we won’t. The #1 headline on Bloomberg this morning is “All Clear Sounded As Markets Shrug Off Black Swans.”
The long-term crisis that markets and Canadian-American small business owners like me are currently facing isn’t that of 2008. It’s a Crisis of Confidence. Not only in America, but around the world, investors who have embraced both the uncertainty and interconnectedness of Global Macro markets are asking themselves whether or not the so called concept of American style “free-market” capitalism is dead.
Sure, if you socialize enough losses… and pay off enough politicians… in the end, a lot of people will be just fine with this – but a lot of people won’t be. That’s why contempt is brewing in the bellies of conservative Americans who have just about had it with Washington’s centrally planned free lunch.
The storytelling of 2008 is over with. The decision point for 2011 is choosing between the individual liberties embedded in the US Constitution and Big Government’s heavy hand of intervention.
This won’t be easy. American Sacrifice never is. George W. Bush should be commended for being transparent and accountable in admitting that he, like most of us, made plenty of mistakes. In the end, I think he’ll admit that perpetually empowering The Man With The Tan Socks was one too.
In his final chapter, as Bush agonizes through the short-term decision making process as to whether or not the US Government should socialize the system for the sake of the “free-market” system itself (ironic way of looking at it really), he circuitously keeps coming back to his roots: “My friends back home in Midland are going to ask what happened to the free-market guy they knew.” (page 460)
I think that’s a very good question President Bush. One that we need to start answering as a country – and soon. Global Macro markets wait for no one – certainly not this time. Memorializing the Bush Tax Cuts works for me, but not Ben and Hank’s modern day expression of socialism.
Flashback: Ben Bernanke and Hank Paulson – “Their opposing personalities could have produced tension. But Hank and Ben became perfect complements. In hindsight, putting a world class investment banker and an expert on the Great Depression in the nation’s top two economic positions were among the most important decisions of my presidency.” (George W. Bush, “Decision Points”, page 452)
Ok. Well there are more than a few ways I can go at that – but what I really want to do is focus on the future. We don’t need an investment banker and a Great Depression historian running economic policy today, tomorrow, or the day after that. Notwithstanding that the US Federal Reserve isn’t supposed to be tied at the hip to the US Government (politicization) to begin with, we don’t need any of this scary storytelling anymore either.
What we need is a proactive Global Risk Manager at the helm of the highest office of the United States who starts by getting these colluding central planners out of our way. What we need is a Strong US Dollar that isn’t being conflicted and compromised at every whim and turn of our US fiscal and monetary policy. What we need is for someone to stand up and take our free markets back to where they came from.
Back to today’s grind…
This morning what you are seeing in Global Macro markets is a massive tug-of-war between the Keynesian Kingdom begging the US Government for Quantitative Guessing Part III (QG3) and the latest version of America Shrugged (Atlas Shrugged, coming to movie theatres near you on April 15th).
GROWTH vs INFLATION
I was on Kudlow last night, and Larry came around to the forecast that I’ve been lobbying him with for the last 6 weeks – Growth Slowing As Inflation Accelerates (Stagflation). This morning you’re seeing more sell-side estimates follow the leader. Consensus estimates for Q1 US GDP Growth have now dropped to 3.35% versus the 3.5-4.5% numbers US stock market bulls were throwing around recklessly a month ago.
As this morphs into consensus, I think the proverbial Battle of the Bulge will be in the US Treasury market where short-term yields (2-year yields in particular, because that’s where The Bernank’s politicization is) can’t make up their mind as to whether or not GROWTH SLOWING gets The Bernank back in the game with QG3 or INFLATION ACCLERATING keeps him in his new geopolitical box.
British attempts to socialize their currency and country seem to have a funny way of being tested and tried before America’s political aristocracy tries the same. In the end, maybe it’s simply because they are older than we are – maybe that just means they get to try to answer President George W. Bush’s question about who the “free-market guys” are first…
The Stagflation Report out of the UK this morning makes the output of former British PM Gordon Brown’s left leaning Keynesian Kingdom policies crystal clear. They pounded the British Pound until they removed Brown from office (he lasted 2 years, 319 days) and now, as a result, on a year-over-year basis the UK inflation rate has risen to +4.4% CPI for February (vs 4.0% January).
Both the Euro (ripping higher) and European stocks (breaking down) are baking in BOE and ECB rate hikes as being for real all of a sudden. That’s how managing Global Macro risk in these interconnected times works – suddenly. And I don’t need a historian in his Tan Socks being advised by America’s crony banking cartel to lead me, my firm, or family through that.
My immediate-term support and resistance levels for WTI crude oil are $97.03 and $103.01 per barrel, respectively. My immediate-term support and resistance levels for the SP500 are now 1277 and 1311, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.