It’s late but want to start with a quick post on what we see as potential off-radar risks that could potentially derail the equity rally. Let’s focus tonight on Japan, which is on the mind of very few traders and investors, in our opinion. The first chart from the IMF shows Japan’s relative debt to GDP and 2011 public financing needs as percent of GDP are off the charts.
Martin Feldstein has recently written the country is heading for a savings crisis,
Japan is heading toward a savings crisis. The potential future clash between larger fiscal deficits and a low household saving rate could have powerful negative effects on both Japan and the global economy…
The household saving rate therefore continued to fall until it was below 5% at the end of the 1990’s and reached just above 2% in 2009. At the same time, the fiscal deficit is more than 7% of GDP.
The combination of low household saving and substantial government dissaving would normally force a country to borrow from the rest of the world. But Japan maintains a current-account surplus and continues to send more than 3% of its GDP abroad, providing more than $175 billion of funds this year for other countries to borrow. This apparent paradox is explained by a combination of high corporate saving and low levels of residential and non-residential fixed investment. In short, Japan’s national savings still exceed its domestic investment, allowing Japan to be a net capital exporter.
We suggest you read the full piece. On the positive side, Japan finances itself primarily with domestic savings, with commercial banks and the financial sector holding the bulk of JGBs. This does raise the potential risk of balance sheet problems for the banking sector if interest rates rise.
The country’s large deficits also likely crowd out flows into equities, which may help explain the dismal performance of the country’s stock market. The market has rallied on the recent announcement the Bank of Japan will be buying equity ETFs. It seems the market does need a surge of foreign inflows to sustain an equity rally, however.
We have been long the dollar against the yen and have been losing money. We anticipated more aggressive action by the Bank of Japan, but may not hold on much longer as Feldstein’s scenario may already be playing out.
Nevertheless, institutions have been betting against Japanese sovereign credit for years and have been losing. We will take a look at Japan again in further posts.