Mental diarrhea II: Raw IM feed on long-term Japan market

by admin on January 24, 2013

Here is some idle chit-chat from an IM exchange with a friend today. I was going to turn it into a post, but…I didn’t. Might be better this way anyhow.


A:  hey long time no see

 me:  Yes

A:  how have u been

 me:  You supposed to be working?

What will your boss say?

A:  lunch time

 me:  If he finds you on Gmail?


I’m in Thailand

I heard a rumor that it is cold in Japan

A:  cool

 me:  You must be doing well with all your chemical stocks

A:  kinda cold but not that bad

r u being sarcastic haha

chem stocks r ok

went down and came back up

 me:  You should have bought some trash

I told you they would print money

A:  haha


I started to get enquiries to translation financial statements

Sent at 12:10 PM on Thursday

A:  sorry got logged out

 me:  Maybe your company is watching you!

A:  maybe

but doesnt matter

i do my job

 me:  So how about this rally?

A:  wier


not fundamentals

curency game

 me:  Well, it is in anticipation of fundamentals

Yes, but if they can keep the yen at this level, then a lot of companies will have better earnings next year

A:  yea in the respect of yen exposure to fundamentals

 me:  The only thing I’m worried about is …

There is a lot of optimism in the world

A:  seems that way

 me:  If we had a risk off period, then the yen would not be able to fall this low

A:  right

so not company specific factors driving the market

macro and currency


 me:  But that’s ok, because earnings will be higher if the yen stays here

A:  but we dont know if it will

 me:  So although you think it is macro, it really is micro in the future

Yes we do – earnings will be higher if the yen is weaker

A:  if u wanna bet on currency better to trade forex

 me:  No

That is a 49% chance of winning and 51% chance of losing – best case scenario

whereas if you buy cheap companies, you have a very high chance of making good money

A:  then u r betting on earnings without forex impact

 me:  Look, I feel that the revaluation so far only takes into account earnings increased next year

Sure, there are a lot of stocks that have gone up very fast

But, overall, I get the impression that we don’t have a liquidity premium in the Japan market now

Relatively illiquid stocks are still cheap

A:  yea as is often the case

 me:  So I think that if the yen stays completely flat for the next year

you need to have a revaluation up even from here

to price in a. expectations of growth due to second-round effects

and b. liquidity premium

A:  for stocks with positive forex expisre

 me:  No

Because we are talking about second-round effects

Panasonic sells more rice cookers,

they need to hire more temp staff in Fukuoka or wherever

the temp staff agency in Fukuoka has higher sales

rents increase…

etc. etc.

A:  oh ok

 me:  That is IF the yen stays where it is

A:  net net positive

 me:  dunno if that will happen

I might write a blog post about this


A:  thats billion dollar q

 me:  Yes, I mean the yen will probably have to rise at some point

A:  who wud expect the reversal six months ago

 me:  because global optimism is too high


A:  what about timing

 me:  That is why I made 34.4% in 2012 before dividends

well, I was early into full investment within 2012, but so what?

In terms of timing going forwards,

read my blog post about “So, how about this rally”

A:  how did u figure yen depreciation late2012

 me:  I did not expect the exact time

but all the indicators were there

A:  in the summar or fall

 me:  stock market depressed

companies complaining of no exports


A:  that every one knew

 me:  So everyone should have been long at least some junky beta trash!

A:  this time it was the regime change

 me:  You see, the actual catalyst is irrelevant

For instance, in the corn market,

A:  ok if u say so

 me:  if the price of corn is so low that

farmers are going broke,

guess what?

The price HAS TO go up

now, the trigger will probably be a USDA report on dry weather conditions

but who cares?

A:  are they going broke


 me:  Well, exporters were going broke

in Japan

A:  bout boost from ethanol

 me:  That don’t matter

A:  well exporters were broke in the uk

and they died

 me:  Yes, but they were structurally screwed

because of the North Sea

and London’s City

Japan has no north sea and no big service exports

A:  exporters in the us died too

 me:  That was because the government of the US allowed them to

The US does not have an industrial policy, unlike Japan

A:  jap govt seemed to allow for long time

industrial policy is nothing like that in 80s

 me:  Not that long really – not long enough for a major company to get taken over by a Chinese company, for instance

A:  70s

 me:  Sure, but still

Will a Chinese company take over a major Japanese technology company?

Almost happened with Sharp

A:  they r taken over tho depending on the definition


 me:  Kind of happened with Micron


A:  and elpida


 me:  But Elpida is a pile of c’ap

A:  market share change across teh is dramatic

 me:  it makes commoditized stuff that you can actually buy futures on

you can buy futures on RAM – you know that?

It is just a commodity

A:  jap govt allowed itto happe

 me:  right, so the wind has changed a bit

But let’s put this in context

A:  well many things r now commodity

 me:  In the US in the 80s

A:  whats left for high end?

 me:  they had the biggest electronics industry by FAR

and they let Japanese companies take over the industry

I mean, that would be the equivalent of allowing Chinese companies to take over the Japanese position in car mfg

 me:  I’m just saying that the degree is not as large, but the Japanese system still needs exports, and when they are threatened seriously then there needs to be change

A:  fair enough

but degree is difficult to guage

 me:  But you see, this is a big big weakness of mine

A:  what?

 me:  I just get focused on markets where there is something that is out of balance

But once we resolve the immediate imbalance, like now, the question of where do we go from here is much harder

But, overall, the situation in terms of the Japanese market for stocks has not changed that much

A:  maybe its still in imbalance

 me:  Still have woeful underinvestment locally

Yes, but this is not going to be fixed in a few months

You need a shift out of bonds into equities

that will take many years

A:  yea many

 me:  And a change in psychology

A:  so imbalance may be a mid term equilibrium

yea i agree

 me:  I see it like this

Basically you have a multi-level problem

Use the analogy of asking a girl out

Firstly, it you need to get over your inhibition to talk to the girl

Once you have sorted out that problem,

you then get to a kind of equilibrium, but now you have a new problem

which is how to get her phone number

Once you get over that problem, …

you see, I think that it is really a multi-step equilibrium

A:  so apparent imbalance may not be imbalance

 me:  That’s not what I mean

A:  well u assume that this guy gonna date or get married or sonething

 me:  I mean that, for example, you may have addressed the problem of insufficient liquidity, or the yen being too high, but you still have the problem of there not being enough ownership of Japanese companies, Japanese companies not investing enough locally, the psychological aversion to investing in Japanese companies, etc.

A:  u assume the definite goal

 me:  So, you can imagine that the yen goes to 100, then the yen problem has been finished, but

the prices of equities may still be cheap

A:  thus insufficiency may continue to persist

 me:  Or, equities may be expensive, but in a few years, all of the cash which companies have will be invested, causing average earnings to rise a lot

What I’m saying, is that That the market can only see what is currently anticipated

But, we can see that there are long-term problems, and the market cannot really see them at the moment

Once those problems start to be fixed, then the market will notice them, and that will impact prices

A:  ok cuz its more certain



 me:  So you have this kind of climbing effect, as you did in the 1981 to 2000 bull market

A:  yea if things take that path

 me:  Because you know, in 1981, shares were cheap, Interest rates were high, and interest in stocks was low

Then, by 1984 1985, stocks became expensive and earnings rose a bit

A:  the decades were in deregulation

 me:  Yes, exactly

A:  new tech

nice demography

 me:  But, in 1984 to 85, the stock market could not see new tech, could not see deregulation, could not see growth in new markets, could not see the fall of the Berlin Wall, could not see the rise of new forms of financing, etc. etc.

A:  communist opening up the market

 me:  yes

So in 1985, the market looked somewhat expensive

In 1986/7 it started getting too aggressive

A:  cud we see it back then?

 me:  No!

That is my point!

A:  ok

 me:  If you were very long-term thinking at that time, then you could think deeply about the future,

And you may have had an idea that long-term earnings will have to improve with all of this new technology, new markets, etc

A:  but how can u expect it to happen again

 me:  But all the market could see is the buying pressure from people investing in funds with new forms of programmed trading

And then the people selling through program trading in the 1987 crash

The market could not see anything else

And, I think that in Japan, the market is just seeing a short-term liquidity effect

A:  ic

 me:  but, I think that if you think long-term, then there will be other effects that are not yet clearly visible



[Addition] And, I think those long-term effects, like anti-stock psychology, like low local ownership, like low private sector capex and low debt levels, will change, opening up the next stages of the bull market.

I welcome hate-mail shooting me down for comparing the Japanese market to the US market in 1981. Suggested shoot-down ideas:

a. but the demographics are different

b. but Japan is so conservative and backward-minded

c. but no one trusts Japan due to bad corporate governance

d. but the government has created a lot of paper promises which it can’t keep unless it causes (likely) big inflation or (unlikely) defaults

e. but Japan’s industrial champions are on their knees

{ 5 comments… read them below or add one }

C3PO January 25, 2013 at 7:31 am

Interesting, I share the view that Japan is a lot like the US at the beginning of the 80s. 4th turning by S./H. formulates some interesting theories about generations and Japan is one of the countries not in sync with the US. Either behind 25 years or 55 years advanced into the future.

I would be interested in the “true” fair exchange rate of the yen. I think it should be in the 60s against the US$ and 70/80s against the Euro, but I can see it going much much lower as the excess of 2007 where the Yen was undervalued by as much as 50% will be corrected. So 30-40 against the Euro is in the cards if we get a deflationary world-wide collaps right now.

And if we get inflation (not 2% but 5-10%) the Yen has priced in many many years of inflation already. In that case the exchange rate could stay around 90 for 10 years.


admin January 25, 2013 at 10:27 am

Thanks for your comment.

I think that one problem here is that the fair value of the yen is a slippery concept.

If you’re thinking about it over the course of a few months, then maybe the default approach is to look at the breakeven rate for exporters.

However, imagine that China decides to subsidize car manufacturers and exporters to steal Japanese technology, hire away the best Japanese engineers (btw, I have heard rumors of this actually happening, but part-time and on a small scale), and invest in marketing infrastructure in the US and Europe. If that did happen, then the fair value of the yen would be much weaker than where it is now. Incidentally, China is forcing overseas companies to co-develop cars with local manufacturers and sell them under the local partner name. The new local cars look just like those of Nissan, Toyota, etc.

In my opinion, over the course of several years the determining factor is not trade flows but capital flows. If you consider the period 2000 to 2009, flourishing trade (increased net export earnings) should have been positive for the yen, but was not. The reason was the offsetting capital outflows.

Now, the scenario you choose affects the outcome in a non-linear manner.

If you choose the global great deflationary depression one, then you basically have very little trade going on and capital suddenly being repatriated into Japan, causing a terrific spike in the yen. How far it could go is a difficult guess – depends on how desperate will be the last yen buyer out there. That scenario is interesting, because Japan still has a large domestic market, and commodity prices will be very low, so living standards may be relatively high, but on the other hand the internal deflation will be exacerbated badly. If this comes to pass the US might then be the best place to be. Will China have severe domestic unrest? Probably. How about oil exporters? Big depression.

On the other hand, a mild recession might involve a yen that is manageable through unilateral central bank manipulation.

Mild global inflation would be accompanied by overheating of certain markets in Asia and interest rates rising in some places, and Japanese companies will inevitably overinvest overseas, selling yen and buying the local currencies, leading to significant weakening of the yen.

A frothy-mouthed global boom might provide, though not immediately, the momentum to get Japanese internal capex moving again, and could set a whole new train in motion, possibly even leading to allocation of Japanese capital back into Japan for investment. So that may even be positive for the yen.

The difficulty I have with the global deflation scenario is that it would require something like a trade war, which governments today are too weak to implement.

A global currency war, however, is likely, in my opinion. Even though other countries might be better at cheapening their currencies, differential inflation will lead to differential interest rates, which will cause capital to come out of Japan, as per the fashion of Japanese investment in the Turkish lira recently, and there should be some Venezuelan-type overinvestment (e.g. buy a car as a store of wealth), which will lead to investment capital exiting Japan.


C3PO January 25, 2013 at 11:08 pm

Yes, there is a “fair” exchange rate: living costs for basic living. I.e. 30-50 sqm apartment, no car, expenses for food, dining etc.

Japan has only a “trash” economy with many crap companies (having only 1 customer and 1 supplier for instance, such a company makes no sense in distribution), mom and pop stores, most of the food is imported, island nation etc. And don’t forget that Japanese products still have higher quality than the export versions.

All those facts would make me think that the price level in Japan should be 30-50% higher than in Western Europe. But no, cost of living in Japan is actually cheaper than over here. Excluding rent the break-even point is in the 80-100 range vs. the Euro.

The Honda Accord is 20% cheaper in Japan than in Europe and that’s a comparison of a Japanese Honda Accord to the UK manufactured one. Which one will have the higher quality?

The Yen is tricky because we’ve had 4% less inflation in Japan than in Europe over the last 10-15 years annually. 2-3% in Europe, -0-1% in Japan and 1% for differences in reporting standards. So the 2000 exchange rate vs the Euro of 90 translates into 55 today inflation-adjusted!

Taking into account the forex mentality of the past decade I think Japan will succeed in generating inflation. Lots of inflation, 4-5%. And I think economies in the West are toast, we will get (mild) deflation. And in that scenario the Yen will rise slightly vs the Euro while the price level difference is eliminated by inflation. And why not? 5% inflation means 6% interest rates (MOF will have to take care of their financing needs I guess…) and 6% is higher than 1% in Europe and the US.

My conclusion:
Sell all Japanese net-nets active in the domestic economy for now. Nintendo alone has made a profit of ca. 300 Yen per share in forex gains in the 3rd quarter. Nintendo is an example for one kind of company good for my “positive” Yen scenario. The second kind is something like Accordia Golf: earnings so so, but huge real estate assets in prime locations, 50% debt financed. An example what could happen to real estate is the forced sale of land holdings by Pacific Golf last year because of a state project: they got 20x the average book value for land in the Kanto region.


admin January 25, 2013 at 11:35 pm

You’re right that things such as the hamburger index can give you an idea of relative purchasing parity/ living standards, and you also probably right with that analysis of the “fair” exchange rate.

However, I don’t think that we can reach an ideal equilibrium “fair” exchange rate when there are other powerful forces in play. Underlying living standards do not change by 20 or 30% per year, but currencies can move by that much, and I think one of the biggest factors driving the yen on the margin (because it is more variable than, say, trade) is the movement of capital into and out of the country.

I am with you on the inflation thing – I believe there just has to be inflation in Japan. How did you come to 4-5%?

And, why will the yen rise slightly versus the euro in that case? Not just due to interest rates, surely? There is no incentive to raise interest rates to cool down the economy until inflation starts to become an issue.

If your scenario comes about, then there will be a greater increase in local stock investments, because shares will be going up with inflation and increased liquidity. Net nets tend to be small companies which are illiquid, and they will go up significantly with increased liquidity, increasing participation in local investment, and greater domestic demand – a bit like has already been happening in the last few months, but on a bigger scale. There are also plenty of net nets which have real estate plays within them. Net nets on the whole are only a bad bet you think there will be continued deflation and stagnation.

Also, using that macro thesis to conclude that Nintendo is buy slightly avoids the whole thing about the industry in which that company belongs to. Now, I don’t know anything about Nintendo, but I know that I can get computer games for $.99 on my iPad, and this has come about only in the last few years. Perhaps you’re an expert, but to me the future of entertainment technology is as clear as carrot soup – even the US companies are looking ill.


C3PO January 26, 2013 at 12:14 am

Of course 20-30% swings are the norm, but forex rates swing in both directions. We had the Yen significantly undervalued in 2007 – a 22 year low in inflation adjusted terms. The Yen rose into slightly overvalued territory, but it should have risen into extremely overvalued territory to offset the 2007 undervaluation. So the Yen appreciation (inflation adjusted, not necessarily forex rate) still has further to go, either in a sudden scenario (deflation) or long-term over 10-15 years (inflation). 4-5% is just a guess.

And yes, the Nintendo business is toast. Not because of smartphones but because they are too dumb to make the right games or right consoles. But short term Nintendo is the perfect investment: lots of gains due to being an exporter, lots of cash in non-Yen (1.9 bn $, 1.3 bn Euro), 250-300 Yen forex gain in 3rd quarter, >10% more revenue due to better forex rates, swing to profitability due to forex. The underlying business is behind plan, with the Wii U selling not very good. So let’s see… However, right now Nintendo has 8400 Yen per share in net cash, hard to argue with that. And in a liquidation scenario the IPs would be worth something too.

My bread and butter over the last couple of years have been pachinko stocks… still have 0.1% of 6257.


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