You may have seen the series on television about a post apocalypse world where zombies roam the earth and what is left of humanity is on the run. The story is centred on Rick Grimes, a small-town sheriff who is wounded in the line of duty and wakes up from a coma facing a new reality; zombies now rule the earth in search of fresh flesh; adapt and survive is the order of the day.
These days I feel like Rick. It seems that I have just woken from a long coma and I am now facing a new reality; a reality where brainless zombies drive the stock market, hunting in packs at any sign of noise, having forgotten any common sense and being only driven by the smell of blood. In a world where fundamentals don’t matter anymore, where technical witchery dictates market direction, where rumours replace the truth, how can an investor adapt and survive? There is definitely a lot of nonsense happening today and the best survival tool remains your logic. Take the time to analyse the world we live in and use this brain of yours before it become somebody else’s lunch. The recipe is to be patient and invest in long-term themes facing unavoidable realities. For the coming years there is no more obvious trade than the collapse of the yen.
From July 2008 to today, the Japanese Yen has gained gain over 30 per cent vis-à-vis the green back ie the USDJPY has lost 30 per cent of its value. If, like Rick, you have just woken up from a long coma, a rapid glance at your Bloomberg terminal would convince you that the Japanese economy is much stronger today then it was in 2008. That the Japanese fiscal situation is improving and that capital investment is flowing into the country. You might also focus you attention on the USA and conclude that the local economy has run in to big troubles, troubles even worse than the one faced by Japan over the last thirty years. Who knows, during your three year coma, maybe the US experienced a major earthquake, a tsunami or even worst a nuclear meltdown?
Of course, nothing can be further from the truth. The situation in Japan is catastrophic. If Europe is on the edge of the precipice then Japan has already fallen off the cliff. We all know that the Japanese debt to GDP now exceeds 200 per cent. However zombie-traders continue to pump the yen higher, as they have been conditioned to do for 30 years, believing that Japan is a safe haven, an investment of choice when volatility increases. Why? Because contrarily to other countries the Japanese debt is mainly owned by the Japanese population. The debt is financed through an important trade surplus, which translates into increased local savings, which in return are used to buy local debts. As the country experienced a deflation of 1 to 2 per cent for the last 10 plus years, and 10 years bonds provide yield in excess of 1 per cent, the real rate of return has remained appealing for Japanese investors with a real return after inflation of approximately 2.5 per cent. Therefore, for as long as the locals are buying, the debt can increase infinitively. The overall investor’s belief is that a near-term disruption in the government bond market remains unlikely as the market sees stable domestic savings rates and healthy current account surplus remaining for years to come. They are wrong.
First the pool of assets directed to savings is shrinking rapidly. Japan has the second oldest population in the world, after Monaco, and savings are gradually morphing into healthcare expenses. Japan also presents one of the lowest birth rates in the world at 1.2 per cent, the highest life expectancy and a zero net migration rate for more then 10 years. Japan is a demographic basket case. According to the Bank of Tokyo-Mitsubishi UFJ, Japanese household savings will cross into negative territory in 2015 – the downward trend is irreversible without a significant change in demographic profile.
Therefore in the next few years, the indigenous buyer of Japanese debts will shrink as the debt increases. The question will then become: As the population ages, reducing its savings and depleting the pension fund assets, who will be buying Japanese bonds? The Bank of Japan will have to turn toward foreigners to continue financing their debt. If Europe is a proxy for the international investors appetite for risky fixed income asset, expect much higher rates on Japanese bonds going forward.
According to Societe General, the debt service as a percentage of tax revenues already exceeded 57 per cent in 2010 and the interest expense was over 27 per cent. Therefore a rate increase of 2 or 3 per cent would simply send the country into “virtual” bankruptcy. Let’s not even consider the 7 per cent experienced in Europe recently. We all know that default is not an option for a government when the majority of the debts is owned by the local population; Japan will only have one solution, to print more and more Yen. Therefore, when our mob of zombie-traders starts smelling the blood in Tokyo’s street, expect the worst.
Short the Yen and/or Japanese bonds. Here are a ETF and a ETN to do so:
PowerShares DB Inverse Japanese Govt Bond Futures Exchange Traded Notes
ProShares UltraShort Yen
If you have access to a currency platform for trading, you may also want to look at going long USDJPY or CADJPY if you are bullish on oil. And finally XAUJPY if you dislike the US dollar and want to be invested in gold.
You may need to be patient for this trade. However remember that the reward can be tremendous. This trade has been deemed the “widow maker” for the last twenty years as everyone who tried to capitalise on it was crushed. I believe that the tide is about to turn. Since 2007 the non-discretionary expenses (social security, education and debt service) has exceeded Japan’s tax revenue. The situation can’t continue forever, more debts, less savings and a weak economy will break the bank.
If like me, you have been on the long end of the USDJPY trade for some time, there seems to be light at the end of the tunnel as recent market lows did not translate in a stronger yen, short the land of the rising debt.
Disclaimer: Clover is currently long USDJPY, CADJPY and XAUJOY in some of its client’s accounts. Clover has no positions in JBGS and YCS. Clover has not made any transactions in any security mentioned in the past 72 hours and will not make any purchases or sales in the 72 hours following publication of this article. Eric St-Cyr is the founder and CEO of Clover Asset Management, a wealth management firm located in the Cayman Islands and servicing clients across the Caribbean. Eric has maintained a financial column in many Caribbean papers and is a regular collaborator of marketwatch.com, a division of the Wall Street Journal. His first monthly Journal column Right on the Money also features in this edition.