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WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT?

Takeaway: Consensus equity bulls won the day thanks to Japan, but, in the end (likely sooner rather than later), we all lose.

“The Death of Active Management” Just Accelerated

Q: What happens when stocks go up every day, across sectors, style factors and countries?

A: Volatility collapses and variance (i.e. return dispersion) disappears.

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - S P 500 Sector Varience

 

Q: What happens when there’s a globally coordinated Central Plan to inflate asset prices – effectively crushing volatility and variance in the process?

A: Asset prices inflate on thinner and thinner volume as investors increase their allocations to passive index exposure in lieu of active management, at the margins.

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - Russell 3000 Turnover

 

Q: What happens when there’s a globally coordinated beta chase facilitated through the rise of relatively liquid investment vehicles like ETFs?

A: Asset prices surge higher, forcing active managers to take on leverage and/or liquidity risk in order to keep pace – effectively calling into question the very need for active management in the first place.

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - Levered Beta Chasing

 

We’re not trying to be trite about this. We won’t mince words either.

 

In that spirit of being frank, anyone who thinks the pension fund industry, retail investors and/or sovereign wealth funds aren’t seriously reconsidering how much they are willing to pay “2&20” or even 60-75bps (for a mutual fund) for exposure to a subpar return profile is smoking peyote.

 

In fact, the latest data would seem to suggest they are shunning active management at an accelerated pace across the globe: http://www.efinancialnews.com/story/2014-10-29/two-major-pension-funds-railpen-bt-pension-scheme-join-hedge-fund-pullback.

 

Obviously, we are in the business of servicing active managers so we do not approve of the risk central planners are imposing upon our livelihoods any more than you do. We are all in this [sinking] boat together…

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - HFRX Global Hedge Fund Index vs. SPY

 

Back to Japan… What a Freaking Disaster

At ~7pm on Friday evening (assuming anyone is even at their desks still “actively” managing risk), you probably don’t need me to rehash what happened in Japan overnight.

 

In short, the BoJ surprised investors by expanding its QQE program to an annual target of ¥80T (up from ¥60-70T prior) – just hours before the $1.2T Government Pension Investment Fund of Japan (GPIF) announced widely telegraphed changes to its target asset allocations:

 

  • JGBs: 35% from a target of 60% prior
  • Foreign Debt Securities: 15% from a target of 12% prior
  • Japanese Equities: 25% from a target of 12% prior (NOTE: GPIF already has 17% of its assets in Japanese stocks, so the delta is less incremental than widely assumed)
  • International Equities: 25% from a target of 12% prior

 

It’s hard contextualize how out-of-left-field this contested move by BoJ Governor Haruhiko Kuroda truly was (5-4 vote, to be exact). Our proprietary monetary policy and currency war models – which are far and away the most robust tools on the Street – suggested Japan had a fair amount of hay to bale in order to justify incremental easing – something Kuroda himself even agreed with us on just days ago!

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - MONETARY POLICY MODEL

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - CURRENCY WAR MODEL

 

Alas, as our early-2013 profile of the man clearly outlined, Haruhiko Kuroda has always been an outspoken proponent of “shock and awe” monetary easing. With the JPY down -2.8% vs. the USD and the Nikkei up +4.8% on the day, it’s clear to say he achieved his targeted shock value.  

 

Interestingly, GPIF has to divest itself of ~¥30T in JGBs – the exact amount of the BoJ is targeting for its increased purchases. It’s also worth noting that the BoJ’s plan to now target ¥8-12T in JGB purchases per month is roughly in line w/ the Finance Ministry’s ~¥10 of net issuance per month. The BoJ is already the largest single owner of JGBs, at about 21% of the float.

 

Let’s follow the bouncing ball here…

 

Debt monetization = currency debasement:

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - FX

 

Currency debasement = rising inflationary pressures; it’s worth noting that mineral fuels account for only 34% of Japanese imports (w/ crude oil accounting for roughly half of that total):

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - IMPORTS

 

Rising inflationary pressures = an eventual rise inflation that threatens to slow Japanese consumption growth even further than it already has:

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - CONSUMER CONFIDENCE

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - RETAIL SALES

 

All  told, yet another recession in Japan is not out of the band of probable outcomes over the intermediate term in the context of the recent loss of sequential economic momentum across a variety of key indicators:

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - JAPAN

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - Japan High Frequency GIP Data Monitor

 

Lots of red developing in the left-most columns of that table indeed.

 

We’ve Never Been in the Japanese Hyperinflation Camp, But the Risk Is Indeed Rising

To top that all off, the consumption tax is scheduled to get hiked by another +200bps on April 1st, 2015 and both Finance Minister Taro Aso and BoJ Governor would like things to proceed as planned.

 

The upside risk (to the economy) is that Shinzo Abe caves into rising political pressure stemming from a recent pullback(s) in public support for his cabinet and pushes out the fiscal tightening to some distant year.

 

In most cases, a lack of fiscal sobriety in Japan is a non-event. But now with such a large investor exiting the JGB market, on the margin, (and others sure to follow) and with Japan careening towards becoming a net capital importer, Abe backing away from his plan to halve the primary balance deficit by FY15 risks a loss of faith in the sustainability of the JGB #Bubble. 

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - CURRENT ACCOUNT BALANCE

 

Who's at risk of having to blow out of their JGB exposures?:

 

  • Banks, which are over-allocated due to persistent surplus deposits: 35.5% of the float
  • Insurers: 19.3% of the float
  • Public Pensions: 6.4% of the float
  • Pension Funds: 3.4% of the float
  • Foreigners: 8.5% of the float
  • Households: 2% of the float

 

This we now know for sure: the more sellers of JGBs that emerge, the more the BoJ is likely to step up its role as a provider of liquidity in that market.

 

That risks triggering a pseudo-hyperinflationary spiral in the Japanese yen and, as it relates to the sustainability of the Japanese economy and everything we discussed above regarding active management, this chart all but confirms our fears:

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - Japan 5  Monetary Math

 

Ladies and gentlemen, we are now fast approaching the other side of our then-bullish [contrarian] thesis on Japanese equities we introduced roughly two years ago.

 

Investment Conclusion: Remain Short of Japanese Equities and Long of the Japanese Yen… For Now

We’re inclined to maintain our short bias on the DXJ and our long bias on the FXY for now. We think recent moves are exaggerated in both directions in the context of a highly likely dearth of incremental Policies to Inflate over at least the next few months.

 

That being said, however, we are actively looking for a rise in cross-asset volatility as an opportunity to exit this position in the coming weeks. In short, we are now wrong on this trade and are seeking to minimize the damage by not covering high (DXJ) and selling low (FXY).

 

WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT? - Idea Flow Monitor

 

Have a great weekend,

 

DD

 

Darius Dale

Associate: Macro Team


The Best of This Week From Hedgeye

Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.

HEDGEYE TV

 $KSS: Still a Short After 2014 Investor Conference?

Retail Sector Head Brian McGough and Retail Analyst Alec Richards give their unfiltered reactions to Wednesday’s Investor Conference. After listening to Kohl’s management team Hedgeye remains bearish on the name.

 

Video | Morning Macro Call 10/28/14

This is a free sneak peek at Hedgeye's Morning Macro Call for institutional subscribers.

HEDGEYE IN THE MEDIA

Video | Keith Discusses The End Of QE And The Beginning of Deflation on Fox Business 

On Thursday's Opening Bell with Maria Bartiromo, Keith McCullough analyzes how to invest in a deflationary environment.

 

CARTOON

It Is Fall After All

The Best of This Week From Hedgeye - Falling inflation russell ust10yr 10.27.14

It’s the season for #Quad4, which means both growth and inflation are slowing.

 

Birds Of A Feather

The Best of This Week From Hedgeye - Dove Yellen 10.29.14

The Fed, led by Janet Yellen, concluded its two-day policy meeting Wednesday. 

 

CHART

@Hedgeye Longs Vs. Shorts #Timestamped

The Best of This Week From Hedgeye - COD 10.30.14

 

Don't Call It Bad!

The Best of This Week From Hedgeye - COD 10.27.14

 

POLL OF THE DAY

Halloween Poll of the Day: Which Central Bank Is Scarier?

 

The Bank of Japan shocked global financial markets Friday by expanding its massive stimulus spending in a stark admission that economic growth and inflation have not picked up as much as expected sending Japanese stocks soaring 4.8% to their highest close since 2007 as the yen skidded to near seven-year lows against the dollar.

 

This lead us to Friday's special Halloween poll question:


Commodities: Weekly Quant

Commodities: Weekly Quant - chart1 divergences

Commodities: Weekly Quant - chart2 deltas

Commodities: Weekly Quant - chart3 usd correls

Commodities: Weekly Quant - chart4 s p correls

Commodities: Weekly Quant - chart5 volume

Commodities: Weekly Quant - chart6 vol

Commodities: Weekly Quant - chart7 sentiment

Commodities: Weekly Quant - chart8 1mth correls

Commodities: Weekly Quant - chart9 3mth correls

Commodities: Weekly Quant - chart10 6mth correls

Commodities: Weekly Quant - chart11 1Yr correls

Commodities: Weekly Quant - chart12 3Yr correls

 

Ben Ryan

Analyst


investing ideas

Risk Managed Long Term Investing for Pros

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.

The Week Ahead

The Economic Data calendar for the week of the 3rd of November through the 7th of November is full of critical releases and events.  Attached below is a snapshot of some of the headline numbers that we will be focused on.

 

The Week Ahead - 10.31.14 Week Ahead


EHTH: Covering the Short (Removing from Best Ideas List)

Takeaway: We added EHTH Short to our Best Ideas List on 2/7/14. Our bearish thesis remains largely intact, but we're out of catalysts until 1Q15.

KEY POINTS

  1. NOTHING HAS REALLY CHANGED: The only material positive news from the 3Q14 earnings call was that IFP commission rates are expected to remain the same in 2015; pushing back an inevitable downside catalyst to 2016 at the earliest.  But the same risks that crippled the business in 2014 remain into 2015.  EHTH still has limited connectivity with the public exchanges (a requisite to selling subsidized plans), which means EHTH may not have the ability to drive enough new account growth to offset its churning IFP members.  All things considered, the setup hasn't changed much from 2014; EHTH could see another down year in IFP membership next year.  
  2. BUT WE'RE OUT OF CATALYSTS UNTIL 1Q15: Open Enrollment runs from 11/15/14-2/15/14.  EHTH will not really know what 2015 will look like until 1) it starts collecting premiums on its new members, and 2) it knows how many of its current members have churned.  The company will issue its 2015 guidance before that occurs, which means that can go either way since it won't really understand its 2015 prospects until its 1Q15 earnings release.  Until then, remaining short could expose us to near-term bullish catalysts on immaterial events (e.g. random news flow similar to last year).  Given that the stock is up following cautiously optimistic management commentary for 2015, we would rather book the gain and get out of the way...for now.

EHTH: Covering the Short (Removing from Best Ideas List) - EHTH   Net Member Growth 3Q14

 

Let us know if you have any questions or would like to discuss in more detail. 

 

Hesham Shaaban, CFA

@HedgeyeInternet

 

 

 


Video | Is There A Bubble in Restaurant Stocks?

In an excerpt from an Institutional Call earlier this week, Restaurant Sector Head Howard Penney fields a question concerning a bubble in low quality small cap U.S. stocks. As competiion heats up in the space CHUY’s odds of beating the larger more well known names in the space appear slim. The restaurants team recently turned bearish on CHUY, adding it to the Best Ideas list as a short.


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

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