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RE-SHORTING JAPAN
Does Bernie Madoff sit on the BOJ’s board?

Today was day 1 of the BOJ policy board meeting and the top issue on the agenda has been what to do to help prop up Japanese banks, which are straining under the weight of their collapsing stock portfolios in a vicious cycle that sends equities lower, in turn.

The banking sector rejected the opportunity to sell preferred stock to the government last December for fear that the stigma would cause a loss of confidence among shareholders and overtures by the central bank last month to purchase concentrated cross-holdings directly from the banks in off market transactions were rebuffed by CEO’s unwilling to publicly book losses (Japanese accounting practices are more opaque than those in the US).

After attempting to lead a horse to water but failing to make it drink on multiple occasions, the BOJ is now trying a new approach. A new program is being discussed which will provide up to $10 billion in subordinated loans to banks whose capital ratios have been decimated by declines in their equity investments.

The hope is that this measure will help maintain capital ratios to prevent spiraling liquidations in the stock market, but the modest size suggests that this is a “band aid” and the impact on domestic credit liquidity could be minimal. The bank is also expected to announce treasury buying to combat rising yield. As of this morning, the Nikkei had rallied 12.67% for the week into high expectations for these and other programs.

By our reckoning there may be good news here for the markets in the short term but not for the actual economy. Extending margin loans to levered banks to prevent them from being forced to sell stocks while buying debt to keep yields low strikes us as just delaying the inevitable. After decades of stagnation Japanese financials are living on borrowed time.

Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via the ETF EWJ today. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. We will leg into our virtual short position at higher levels if the rally continues. Everything has a time and a price.

Andrew Barber
Director