Sunday, 22 June 2014

Can PM Abe's Financial Balm Overcome Negative Demography?

Japanese PM Abe has postponed his victory lap, as the author of a policy that has overcome the demon deflation which has plagued Japan for decades.  We will get another assessment of the program's success on the 26th of June we will get new CPI numbers.  It is anticipated the Tokyo CPI will be up 3.1%, the same as the previous month.  For all of Japan, the CPI, excluding food and energy, the number is projected to be up 1.9%, the same as last month.

Earlier, it was reported the GDP for Q1 was a positive 1.6%, better than the previous forecast of 1.5%.  Some think this will compound to a yearly gain of 6.7%, but these people may have ingested some Colorado cookies.  First quarter growth ballooned ahead of the April increase in the consumption tax.

The reallocation of asset classes with in the Government Pension Investment Fund (GPIF), urged by PM Abe, is another facet of Abenomics.  Combined with the Post Office savings plan, the total size of these two funds is over $2 Trillion.  As mentionedhere, these two funds have been urged to sell their ownership of the Japanese Government bonds and invest in riskier assets such as Japanese and foreign stocks and foreign bonds.

With billions of buy orders anticipated as the funds are reallocated, the front runners, buying the Japanese stocks, have been having a grand time.  It was reported in the Nikkei Asian Review foreign ownership of Japanese equities was up to 30.8% of the market as of March 31st.

"Further, foreigners did roughly 60% of the trading in Japanese equities in the year ended March 31, buying a net 9.5 trillion yen ($92.2 billion) of shares."

The Nikkei 225 closed the week at 15,349, down from the higher earlier this year of 16,232.  Anticipation of the reallocation of the retirement funds should provide support under this market.  Also, remember the aggressive QE program by the Bank of Japan (BOJ), which provides over $50B of funds per month, money available to also buy stocks.  Many global equity averages are flirting with all time highs, but in Japan the Nikkei 225 is less than 40% of the high, 38,915 in December of 1989. 

Is the market rigged by the government and the BOJ, and we are headed back toward that high?

Among the critics of PM Abe's plan, is Kazumasa Oguro, formerly an economist at the Ministry of Finance, and currently an assistant professor at Hosei University.  While the $2T of retirement funds seems amply, Professor Oguro contends Japan will be unable to meet the social needs as the population ages:
While the U.S., U.K. and EU each publish long-term financial forecasts of their social security systems to at least 2060, Japan, Oguro said, projects only nine years out, to 2023. Moreover, in 2002 it ceased including off-balance-sheet items of social welfare and medical entitlements in its forecasts. This way, it can paint a rosier-than-reality picture of the sustainability of Japan's social security systems.

According to his projections, the proportion of Japan's gross debt to GDP will rise from its current 190% to an unsustainable 500% by 2050. The government currently borrows 50% of what it spends every year. Gross national debt is now 20 times tax revenues. Clearly, this trend cannot continue indefinitely, Oguro said.

Behind the sharp rise in debt-to-GDP ratio lurks the decline of Japan's working population – 15-64-year-olds – which is projected to shrink by about 1 million a year until 2060. According to the National Institute of Population and Social Security Research, the number of those 65 and older will increase by 330,000 each year through 2040. By 2060, the ratio of working age taxpayers to elderly (mostly pensioners) will shrink from 3:1 to almost 1:1.

Pension and health care entitlements are already the largest central government expenditures - representing 33% of the national budget, followed by debt service costs. Entitlements, growing by almost 1% annually, are expected to explode by 2025, when all baby boomers will be at least 75.
Painful solutions to the myriad of problems are available but politicians like to keep their jobs, the pensioners like to get their benefits and the Japanese are adverse to immigration.  With 44% of the voters over 60, and only 13% in their 20s, the ballot box will not result in the necessary changes.  What is needed is a crisis; then, necessity becomes the mother of invention.

Currency speculators have had big short positions in the yen for months,  but the USDJPY is trading at approximately the same price as it traded in May of 2013.   At the beginning of 2014 the speculative yen futures short was 175K contracts.  The USDJPY was slightly above 105, and the high for the USD against the yen for the year.  Since then the low has been 100.70.

Click to Enlarge USDJPY Daily Currency Chart

Specs remain short, but that futures position has been reduced to 96.1K in the June 17th COT report.  Recently, the trade has been confined to an increasingly narrower range.  Eventually the market will break from this range.  The longer the pair continues within this narrow range, it usually means the move in the break out direction will be larger.  Currently, this suggests a 5/700 pip move is possible.

But which way?

Longer-term fundamentals are bearish but the crowd is already positioned for this move.  It is possible we could see some misguided yen haven buying considering the unsettled geopolitical situation.  We prefer the buy the USD and sell the yen in the 100/101.50 area, a level that may occur should the yen shorts cover.   Should this price not be available, we may be willing to pay more later.  There appears to be yen selling when the trade goes under 102.

Our preference remain on the short side but the market is saying there is no great urgency. 

As always, manage your money.
Ralph Shell, Excel Analyst
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