On August 30, the Bank of Japan, the country’s central bank, announced a major new program of monetary stimulus. The governor of the bank even flew back from the Federal Reserve’s Jackson Hole conclave for the world’s central bankers. The Japanese government announced what it billed as significant new economic stimulus package.
And the financial markets blew a giant raspberry. The moves had been designed to slow the relentless appreciation of the yen, which has killed Japanese exports by making them so expensive and which threatens Japan’s economic recovery. But the yen actually climbed to finish the day at 84.5 to a U.S. dollar. That’s not far off the 15-year high for Japan’s currency set lat week.
The yen seems doomed to keep on climbing. Japanese exporters seem doomed to keep on sinking. The country’s economy seems doomed to sink back into recession. And the central bank and the Japanese government seem powerless to stop it.
And that’s not the end of the gloom in Japan. The country recently slipped from No. 2 to No. 3 in the listing of the world’s largest economies. The government is bogged down in endless infighting. The country is one of the fastest aging in the developed world. And some of the country’s great corporate icons—Toyota Motor (TM), for example—are better, these days, at producing recalls than cars.
Japan is still the world’s No. 3 economy, and home to some of the great export companies with some of the most recognized brands in the world economy. It’s corporate resources in robotics, biotechnology, and industrial materials research and development are among the world’s leaders. It’s stunning government debt is supported by one of the globe’s deepest pools of consumer and corporate savings.
So bring on the doom. Write off Japan. Sell Sony (SNE), and Toyota, and Honda Motor (HMC), and Canon (CAJ). The yen will turn one day—in spite of all the dysfunction of Japan’s politicians. And the tide that has drowned even the best of Japan’s companies will recede to leave that best still standing. And when that tide turns, I’d like to be able to say that I picked up some of those great companies at doom and gloom prices.
Let’s start off by understanding why investors are so gloomy about Japan right now.
The yen is the focus of the gloom but it’s a symptom of the problem and not really the cause.
The yen has become the global refuge of choice. That seems odd given the country’s economic, political, and demographic problems. But for the short-term, and that’s all that currency traders and safety hunters are looking at, those negatives are outweighed by the positives of the Japanese currency.
First, perversely, the country’s economic and political problems just about guarantee that anyone buying yen in the form of government notes or bonds won’t get blindsided by a rise in interest rates that sinks the value of their holdings. The Japanese government isn’t about to raise rates. It would lower them if it could.
Second, perversely, the inability of the Bank of Japan or the Japanese government to do anything effective to weaken the yen means that buyers of yen don’t have to worry about currency intervention sinking the value of their yen positions.
Third, to own yen, you don’t actually have to have cash. In other words you don’t have to raise money by cashing out other investments to buy yen. You can simply borrow in the yen market to buy yen instruments. Because interest rates in Japan are so low if you want to borrow yen to buy yen, and you’re a big institutional investor, you’ll pay almost nothing. That makes the yen an ideal hedge on other investments since you don’t have to sell those investments to put on the hedge.
Fourth, as long as we’re speaking of hedges, the yen and the U.S. economy are very attractively inversely correlated right now. The yen rises when worries about the U.S. economy increase. Want to hedge the risk of U.S. stocks? Buy yen. Want to hedge the risk of European markets? Buy yen.
And lastly, fifth, buying yen is a bet on a very strong and clear trend. You buy yen until data and attitudes toward the U.S. economy and global assessments of risk change. Then, because the market is so liquid, you simply sell. (We’ll see if the “Everybody can get out without a problem” optimism is justified this time.)
If you think about the strength of the five reasons behind the yen’s climb that I’ve just quickly outlined, you’ll begin to understand why the financial markets were so unimpressed by the moves by the Bank of Japan and the Japanese government.
The stimulus package announced by the government amounted to about $11 billion. A drop in the bucket in an economy as big and as troubled as Japan’s. The program just continues what we know is a failed policy. Japan has been so unsuccessful at stimulating its way to higher growth not because the government hasn’t spent anything, but because the government persists in dribbling out stimulus funds in small amounts with each package separated from the ones before and after by months of confusing pronouncements about what the country needs to do next. (If this sounds to you a whole lot like current U.S. policy, post the big stimulus package of February 2009, of very small stimulus (excuse me, “jobs” bills) separated by hemming and hawing about the need for more fiscal discipline, then I think you’ve got it exactly right. And the similarities aren’t a good thing.)
The Bank of Japan’s big move was bigger—at $120 billion or so—but it wasn’t very daring. The bank announced that it would expand its program of lending at very cheap rates in an effort to get the economy going. But that will do nothing (except maybe eventually if the economy does recover) to stop the rise of the yen now. The Bank of Japan could have used the money to intervene in the currency market by selling yen in an effort to drive down the price of yen, but the bank is, with good reason, afraid that this won’t work. Efforts by the Swiss central bank to stop the rise of the franc by selling francs failed miserably and expensively. And the Bank of Japan knows that if it intervenes and the intervention has no effect, it will remove the last worry that currency traders and speculators have about buying yen. Better to keep that worry as a deterrent—even if it’s not a very effective one. (For more on the limits of intervention and why the bank has so far not gone down that road whole hog see my post http://jubakpicks.com/2010/09/01/can-anyone-stop-the-appreciation-in-the-yen-not-the-bank-of-japan-or-the-countrys-government-it-appears/
If the Bank of Japan doesn’t want to buck the currency markets, why would I want to try?
Well, I don’t quite yet. I think we’ve got months of depressing U.S. economic news ahead of us that will keep the yen moving higher.
But at some point a lot of the reasons that I’ve given for the rise of the yen turn into reasons for the yen to retreat. Not massively, mind you. The consensus on Wall Street is that the yen will finish the year around 90 to the dollar instead of 84 or so now. I think that underestimates the effect of everyone now long yen running for the hills at once. But whatever the yearend value of the yen, the direction will have definitely reversed.
And at 90 yen to the dollar the best Japanese exporting companies will be profitable. They’ve pegged make or break for their sales and profits at 83 yen to the dollar. If the yen gets any higher than that, enough customers will be priced out of Japanese products to take even the best exporters into the red.
That makes a turn from the current 84 to 90 or so, a way to leverage any improvement in attitudes toward the U.S. economy. If investors think the U.S. economy is improving that will take the yen down versus the dollar and that will radically change the profitability of Japanese exporters.
What kind of a Japanese company do you want to buy, when the time is right, to take advantage of this shift and leverage?
Canon (CAJ) is almost a perfect model. Relatively low sales in Japan—just 22%in 2009. A relatively high exposure to the U.S. consumer (28% of sales from the Americas.)A relatively late effort to move substantial production out of Japan so that the company is really getting killed on the strong yen and its effect on sales. But a global leadership in its industry: there’s really nothing wrong with Canon that a weaker yen wouldn’t fix.
I’d suggest two other stocks to consider for this strategy when we’re close to a turn in the yen/dollar relationship:
Heavy construction and mining equipment maker Komatsu (KMTUY). For more on the company see my post http://jubakpicks.com/2010/08/31/if-the-economy-is-so-terrible-why-are-machinery-stocks-relatively-strong/
And textile and carbon fiber maker Toray Industries (TRYIY). For more on the company see my post http://jubakpicks.com/2010/07/30/put-more-fiber-in-your-portfolio/ .
Did I hear someone ask “When?” I’d look to put real money into some Japanese stocks right around the U.S election in November. Whatever the results of that vote, the vote will remove some of the uncertainty from the U.S. political and economic situation. At least in the short-term.