Friday, May 13, 2011

Japan: The Land of The Setting Sun

*** PRESENTATION UPDATE: June 2011 ***

Find below a presentation I put together in January/February about Japan.

After reading a lot about the subject from people like Kyle Bass, Hugh Hendry, John Mauldin, David Einhorn and others, I decided to study it too. I like these guys because they demonstrate they have sound investment processes and play their ideas through ways that give them a big upper hand in case they're right x what they would lose if wrong. A lot of money managers do the opposite. They gain small for a long time until they don't. And they're gone.

The data presented was sourced from a variety of entities and might not be 100% accurate/on the spot, but it sure gives you a very good idea about where Japan now stands in terms of growth potential, debt sustainability and risk-reward. It hasn't been updated to include after-earthquake/tsunami economic data and governtment/central bank response, however these tragic facts only make the case even more interesting. In my opinion they only increased the probability of my desired outcomes.

At the end I presented trade ideas that, together, from what I call the pillars for the bet against Japan.
Pricing has, of course, changed since then, but not a lot. As others have mentioned, the asymmetry is huge.

The final word on this trade is simple: confidence. If the music stops for JGBs, Japan could be gone quickly.

And if the trade proves to be correct the owner of the bets must therefore be worried about who the counterparties are. Because OTC dealers could be wiped out.

The Tail Chaser - The Land of the Setting Sun

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com


  1. so what are your thoughts on long japan equities with JPY risk hedged?

  2. I have no opinion to be honest.
    One thing is to look at the macro variables and another is to look at corporate earnings.

    For example, the US economy now, with overdose in fiscal and monetary stimulus, delivered tepid growth in the past quarters when compared to previous recoveries. Even absolute levels in growth, compared to potential growth (output gap/slack) is still pretty bad.

    But still, earnings growth for the S&P 500 companies was very robust since 2009-lows and margin expansion was there (productivity gains and the collapse in inputs costs [commodities/job cuts]), meaning that the current level of ~1337 for the index is quite alright. But it represents that the present is extrapolated into the future.

    My point here is that the present is a picture of what was done. Overdose in stimulus of all kinds. And that wasn't enough for 'escape-velocity growth'.

    And the Japanese macro story is the same: the BOJ is now BUYING not only government bonds, but ETFs, corporate bonds, REIT, etc. Will this last forever? Is this attitude (their boosted quantitative easing program, boosted even further after the quake) eternal? Does this help risk-asset prices (not only in Japan, but globally)?

    So these are questions to have in mind considering risk-asset prices today. When will the stimulus fade and what will the consequences be? How do I hedge this risk?

    The micro side of the story is that there will always be some interesting investment stories available, but the landscape is full of mines hidden at the moment.

    From the top of my mind I would say that there are many japanese companies with considerable earnings from abroad (China/EM). So these should have smaller correlation with the domestic economy and higher correlation from emerging economies with higher real interest rates, population growth, domestic demand, etc, etc.

    My humble take: just do like all the other experienced investors do. A lot of research, margin of safety, etc. I'm not sure what the currency of your capital is, but with these low interest rates all over the globe it is likely that hedging JPY exposure (especially on the short-end of the NDF/DF curve) will cost you next-to-nothing.

    Thanks for dropping by.
    The Intrigued Trader

  3. Although I just came across the presentation, I really enjoyed it. I have been short JGB's for about 7 months now. Just curious, where in Taiwan do you live? I'm from the U.S. but have been living in Taiwan for the past 3 years.

  4. Although I just came across the piece, I really enjoyed it. I have been short JGB's for about seven months now and believe Japan has passed the rubicon to use Kyle Bass's words. Where do you live in Taiwan? I'm from the U.S. but have been in Taiwan for 3 years.

  5. I actually live in Rio/Brazil, mate.

    It is dirt cheap now, more than in 2011, to buy JPY swaption payers.

    I am not sure the rout starts with a weakening currency. I think that at first the 55% of GDP in japanese non-JPY-denomonated assets would be repatriates, making the Yen stronger (50/USD) for a brief period, which would crush the exporters, therefore crushing the local economy, tax revenues, and then a collapse in bonds and currency due to massive monetization of debt.