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McAlinden
Research Partners
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Japan –
Long stocks, short yen, closing short bonds
Launched:
December
19, 2012. Short yen retired May
2, 2014, and reinstated September 15, 2014. Short bonds retired
March 26, 2015.
While
Japan's prime minister and his allies overpromised what they could
deliver in their first 2 years of reform, the keystone is finally
falling into place: wages are going up. That inflection point gives more
support to the Abe Trade of being long stocks, short the yen, and –
eventually – short JGBs.
Shortly after taking power in late 2012, Abe's team flooded the system
with fiscal and monetary stimulus to boost growth and lift prices, in
part through a weaker yen. In theory, the economy would be wrenched out
of its deflationary spiral, and structural reforms would keep it out.
Last year's headwinds, however, slowed the project dramatically: a
consumption tax hike lifted headline inflation but eroded consumer
spending faster than wages rose, hitting growth harder than most
observers expected, ourselves included.
This year, as today's Daily Intelligence Briefing shows, those forces
are reversed: wages are set to rise briskly, the next scheduled hike in
the consumption tax has been delayed, while the weaker yen and –
especially – falling energy prices have pushed inflation back
down. The clear risk is that inflation drops too much and deflation
comes back. However, unless oil plunges another 50%, the base effect of
last year's drop will begin to fade later this year. The consensus among
economists as tracked by Bloomberg shows inflation bottoming by 3Q15 and
reaching the Bank of Japan's 2% target by 2017. Provided inflation
expectations hold up, in the meantime, lower inflation means real wages
are set to surge.
Green and red dots represent launch and close dates. Source:
Bloomberg, McAlinden Research
While Japan's policymakers have much more to do, particularly regarding
structural reforms, the turn in wages represents an important inflection
point that has helped lift stocks to multi-year highs, the first piece of
the Abe Trade, and MRP believes there is more to go with 90% odds. Given
MRPs cautious outlook for US equities over the next few months, however,
there is a risk that Japan's stocks get caught in the downdraft, at least
temporarily.
For the second piece, the yen already had another sell-off late last year
and has since stabilized, but could weaken further if another round of
monetary easing is adopted, the odds of which MRP currently puts at 50%
through the rest of this year and will update regularly.
The final piece, a short on JGBs, has yet to click in: Japan's quantitative
easing has tempered any possible rise in yields that would push prices down,
while Europe's adoption of its own QE has pushed a third of eurozone
sovereign bond yields below zero, spurring investors to find positive yield
wherever it is to be found, including Japan. As those dynamics run their
course, Japan's bond yields could finally begin to rise. MRP puts those odds
closer to 20% this year and better than 50% by next year, with near zero
odds that already low yields dip into negative territory like in Europe.
While long-term investors might want to keep a short on Japan's bonds, MRP
is stepping aside for now and will revisit that part of the Abe Trade later.
Last
updated March 26, 2015
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