Rumors of the Imminent Death of JGBs are Greatly Exaggerated

The Japanese Diet's failure to raise the sales tax in the early hours of Wednesday didn’t do much to rattle Japanese bondholders, despite Japan's new found balance of trade deficit and a sharp weakening of JPY.

Higher energy imports necessitated by shutting down almost all the country’s nuclear reactors helped turn the trade balance negative for 2011, and is also weighing heavily on Japan's current account surplus, which some economists suspect will also turn to deficit within as little as five years.

Japan's government is heavily indebted and politically unable to take any definitive action to turn the tide, despite lots of movement to significantly raise consumption taxes. The prevalence of scenarios outlining a looming fiscal crisis are convincing, and hard to logically deny. Yet JGB yields remain low, as Japanese financial institutions continue to support JGBs even as they run risk scenarios trying to measure the potential balance sheet damage of a sudden back-up in JGB yields.

The Japan Securities Dealers' Association data on domestic institutional JGB trading, which shows heavy selling of JGBs, are misleading. The BOJ's flow of funds data show significant (JPY14 trillion) net buying on much higher growth of deposits than bank loans (a nearly five-fold difference).

This means that selling JGBs short is still a "widow maker" trade.  The end game will come for JGBs when and only when cash-flush domestic institutions and corporates simply refuse to accept the 1%-plus coupons offered. As it stands now, domestic institutions are shifting away from equities, especially domestic equities.

FT Alphaville

Saudi Oil Minister: Current Oil Prices Based on Shortage Myth

"Supply is not the problem, and it has not been a problem in the recent past. There is no rational reason why oil prices are continuing to remain at these high levels."

Financial Times

Japan Stocks More Closely Track Won-JPY Rate

Deutsche Bank research shows that performance of Japanese stocks has been more correlated to the Won-JPY rate than the USD-JPY rate over the past three years, and the Won has risen about 12% versus JPY since the beginning of 2012, pushing the Nikkei 225 up to its highest level since the March 11, 2012 earthquake.

Because Asia is Japan's No.1 overseas market, the relative strength of these Asian currencies against the yen can have a significant profit impact.

Wall Street Journal 

A New Yen for Japan's Stocks

"Investors are quietly showing a new respect for Japan's long-suffering stock market. The U.S. exchange-traded-fund market's biggest Japanese-stock tracker (EWJ) crept onto the week's list of the top five U.S. asset gatherers among ETFs. The weaker yen has put some pep into Japanese stocks, helping drive the Nikkei up nearly 20% for the year.

Yen-hedged funds have kept better pace with Japan's stock market. The Wisdom Tree Japan Hedged Equity (DXJ) is up about 16% YTD, The newer DB-X MSCI Japan Currency Hedged Equity (DBJP) is up about 19%. To Japan bulls like Neil Hennessy, chief investment officer of Hennessy Funds, things are looking up. Hennessy views post-tsunami and -earthquake infrastructure spending as an aid to the weak economy and the yen's dive as another push in the right direction.

Barrons

The Sony Schism

When Hirai becomes Sony's (6758.T) president and CEO on April 1, he takes charge of a company facing a crisis unlike anything it has experienced in its nearly 70-year history. Sony's issues are much deeper than where to go with the TV business. Hirai faces a fundamental divide in the company that pits an old guard of engineers, mostly in Japan, against device-agnostic content champions, many of them in the movie and music centers of the United States.

While Sony's stock price remains at decade lows, with weaker ties to its main bank than rivals such as Panasonic (6752.T) and Sharp (6753.T) , it counts fewer big lenders among its top shareholders and is more than 40% owned by foreigners.

Analysts' estimates value a broken-up Sony at as much as $25 billion, representing a return of around 20% for any buyer with the moxie to grab one of Japan's best known firms currently worth around $21 billion. That break-up valuation is based on multiples of earnings of its movie and music businesses, the consumer electronics unit, games division and insurance business. The brand value alone is huge. London-based branding agency Interbrand estimates the Sony name is worth $9.9 billion, ranking it at 35 in its annual list of the world's most valuable brands. Samsung at 17 overtook Sony in 2005 and Apple at 8 in 2008.


Reuters Special Report

Taiwan Apple Supplier Hon Hai to Take 11 Pct Stake in Sharp

Taiwan's Hon Hai Precision Industry Co (2317.TW) will take an 11% stake in Japan's Sharp Corp (6753.T) , Sharp said on Tuesday, under a tie-up in LCD production that includes Sharp issuing 66.5 billion yen ($803 million) worth of its shares to four Hon Hai group companies. Hon Hai, an Apple (AAPL) supplier, will hold a 46.48% stake in Japan's main Sakai plant, in western Japan.


Reuters

Production Returns to Quake-Hit Tohoku

Manufacturers are returning to the Tohoku region. Nissan (7201.T) will be producing 300,000 engines/year in its Iwaki Fukushima plant in FY2012,  Toyota Motor (7203.T) at its Kanto Auto Works subsidiary in Iwate will be producing 30,000/month of its popular hybrids, and production has been boosted 50% vs original plans. Nippon Paper will resume operations at its Ishinomaki mill, while JX Nippon Oil & Energy has restarted its Sendai refinery, the only one in the Tohoku region.

Even seafood processors are rebuilding. Abecho Shoten is building a new factory to be operating by 2013 for frozen saury and mackerel, when production capacity will exceed pre-disaster levels. Kawamura Co. is also building a new seafood processing plant this year. Riken Vitamin (4526)  will restart processing operations at the main factory of subsidiary Riken Foo.

Japan Real Estate Now Undervalued vs Asia

Japan's real estate stocks have rallied strongly as investor money returns to Japan real estate on the view it is now undervalued vis-a-vis other countries in Asia. 

The government's land price survey, a lagging indicator, shows property prices are bottoming-out in urban areas. As of January, average prices in Tokyo, Osaka and Nagoya were down 1.6% versus a 2.5% YoY drop in Jan. 2011.  J-REITs are active, acquiring JPY714.4 billion of properties in 2011, including the purchase of Mitsubishi Heavy's headquarters building in 2011 by a consortium lead by Nippon Building Fund (8951). This is roughly triple the bottom in 2009. Property prices in the Tohoku region, hit hard by the March 11, 2011 disaster, are bouncing back as companies return to the region and begin rebuilding. 

British real estate firm Grosvenor resumed investing  last autumn, buying upscale rental condominiums in Tokyo's Roppongi and Minami-Azabu districts, while Singapore and China sovereign wealth funds were buying 15 logistics facilities, as the spread between investment returns and long-term rates in Japan has widened to 5.12%, versus a mere 1.77% in Hong Kong and 2.07% in Singapore.

Expectations for JPY to Depreciate to JPY95/USD in 2013

Rising U.S. short-term bond yields are making the dollar less attractive as a funding currency, leaving the yen as the main alternative. A surprise decision by the Bank of Japan in February which signaled a more aggressive policy easing stance has cemented those expectations.

JPY bear traders, like Chris Turner, head of currency strategy at ING in London, now see USD/JPY ending 2012 at 85 and rallying to 95 through 2013 as Fed tightening expectations build. Bearish bets against the yen placed by speculators more than doubled in the week to March 13 and exceeded those of yen bulls by roughly $6.4 billion - the largest net yen short bet since last April, Commodity Futures Trading Commission data showed. This compares to some $19 billion worth of net yen shorts in late June 2007, when the yen shorts on CFTC hit an all-time high and the dollar peaked out, having risen roughly 20 yen over 2-1/2-years, partly on the popularity of the carry trade.

Reuters

JPY Needs to be 40% Cheaper

Not one to be shy about making bold statements, Andy Xie,  former Morgan Stanley star chief Asia-Pacific economist, has unloaded on JPY.

"The country’s (Japan's) Achilles heel is losing trade competitiveness due to the destructive impact of deflation on business confidence and the strong currency itself. When a trade deficit emerges, it signals the beginning of the end. Japan has only one way out – a massive devaluation. If the stable national debt is 120% of GDP, the yen needs to be devalued by 40% because devaluation is ultimately equal to the nominal GDP increase. The devaluation is likely to sustain 2% to 3% of nominal GDP growth for Japan beyond the repricing induced increase, which is necessary to restore Japan’s tax revenue. Deflation has caused Japan’s tax revenue to decline as a share of GDP. It can be only reversed through restoring nominal GDP. A devaluation of 40% can restore Japan’s competitiveness against Germany and South Korea, which will lay the foundation for Japan’s industrial recovery."

Problem is, a 40% devaluation of JPY could also trigger a fiscal crisis, as JGB yields. As Xie points out,  the JGB interest expense with JGBs at 1% is already expected to top JPY22.3 trillion in the fiscal year that begins next month, or one-quarter of the general account budget. If debt service costs rise to 2%, the interest expense surpasses the total expected tax revenue of JPY42.3 trillion.

The Big Picture

Kansai Region Could Still Experience Power Shortage this Summer

The Nikkei previously reported that Idemitsu Kosan Co. (5019), Inpex Corp. (1605), and Mitsubishi Materials Corp. (5711) have decided along with Japan Petroleum Exploration (1662) and Mitsui Oil Exploration Co. to build Japan's largest geothermal power plant at a cost of some JPY100 billion in Fukushima Prefecture.

On Monday, Nikkei reoported that Canadian Solar Inc. and Hakuto Co. (7433) will start a large-scale solar power plant in Mie Prefecture as early as this fall, the first mega solar project involving a foreign firm. The plant will use Canadian Solar's solar power cells with a total output of 2,000kw, or enough electricity to power roughly 600 households and will be sold to utility companies based on a new program that requires utilities to purchase electricity generated from renewable energy projects at fixed prices.

Meanwhile, Tokyo Electric Power (9501) is shutting down its last operating nuclear power plant, the No. 6 reactor of the seven-unit Kashiwazaki-Kariwa complex in Niigata Prefecture, or regular maintenance and will suspend operations. This leaves only one nuclear power facility, the No. 3 unit of Hokkaido Electric Power's Tomari plant, the only nuclear power reactor in operation of a total 54 commercial power reactors before the Tohoku earthquake/nuclear power disaster. This reactor will also be suspended by early May, also for scheduled maintenance.

Japan's Nuclear Safety Commission has endorsed the stress tests results on two Kansai Electric Power (9503) reactors, and the government aims to win the local community's consent to restart them next month. Prime Minister Yoshihoko Noda will determine whether to restart the Nos. 3 and 4 reactors at Kansai Electric's Ohi plant in Fukui Prefecture, but has yet to win the support of local residents for the re-start.  Based on estimates from last year, Kansai Electric faces a power shortage of 19% assuming a hot summer in 2012. Even with a normal summer, the Kansai Electric service area faces a power shortage of some 9%, or some 41 days between July and September where demand could exceed supply, implying the same kind of rolling power outages in Kansai that Tokyo saw last year.

Japan Bank Stocks Ready to Play Catch-up

Wall Street has suddenly become full retard bullish. The bullish scenario we most agree with is the Citigroup call, that sees North America becoming "the new Middle East" as oil and gas production skyrockets in the next 8 years due to strides in natural resource extraction.  Citi economists expect total liquids production to as much as double for the continent in the next decade, and predict that the U.S. could overtake both Russia and Saudi Arabia in oil production by 2020. The impact on real GDP would be an increase of 2.0% to 3.3%—$370 to $624 billion—as a consequence of new production, a decline in energy consumption, and the economic activity generated along with this. They also see the current account deficit could shrinking by 80% to 90% due to energy exports at an already low level of production, and predict that the current account balance could move from -3.0% of GDP to -0.6% of GDP by 2020, pushing the value of USD up by 1.6% to 5.4% percent.

Late in 2011, the Wall Street Journal  was already pointing out that soaring U.S. exports of gasoline, diesel and other oil-based fuels was putting the U.S. on track to be a net exporter of petroleum products in 2011 for the first time in 62 years, based on data by the U.S. Energy Information Administration.

Goldman Sach's portfolio strategists are presenting a big long-term bullish case for stocks relative to bonds. The report is titled The Long Good Buy; the Case for Equities, and it essentially makes an equity-risk premium argument that stocks are just impossibly cheap relative to bonds, with the scenario currently being priced into the markets being unrealistically negative... even with the long run up in stocks since early 2009.

Others appear to be more opportunistic. Ex-Morgan Stanley strategist and Traxis Partners LP hedge fund manager Barton Biggs now says he is 90% bullish, referring to the proportion of his fund that benefits from higher share prices. “There is an awful lot of money that is out of stocks and in very low- yielding fixed-income instruments. I think the odds are that money is going to migrate back,” he was quoted in Bloomberg. His optimism however has fluctuated along with the market, with at least eight changes in the past six months, says Bloomberg, and from his days at Morgan Stanley, could be called "weather vane Barton. Vince Farrell, the retired chief strategist of Ticonderoga, called this "the best buying opportunity for stocks in 40 years". Bank of America and Credit Suisse recently have taken up their full-year projections for S&P 500, while JPMorgan Chase has remained strongly bullish, and BlackRock CEO Larry Fink several weeks ago said investors should have a "total allocation" to stocks.

Individual U.S. investors so far aren't buying this new-found bullishness, as it comes three years after the depths of the March 2009 low of the 2008 financial crisis and investors are wondering how much higher stocks can go. According to the Investment Company Institute data, investors continue to pull money out of stock-based mutual funds and shovel it into bond mutual funds, even though the "pros" think bonds are a train wreck waiting to happen.

Our concern is that the pros have become too complacent, judging from the VIX S&P 500 volatility index, which is now back at new lows. The last two times the VIX was at these levels, the S&P500 sold off sharply on renewed growth scares triggered by (premature) indications from the Fed they were backing off extraordinary QE measures, and a visible worsening of the Euroland sovereign debt crisis.

Source: Stock Charts.com

Even if the Citigroup scenario is eventually right, stock prices are not going to go shooting to new highs without some backing and filling and a significant correction or tow. Two long-term refinancing operations by the ECB have significantly alleviated the pressure on Euroland bank balance sheets and Greece has finally got its funding and creditor haircuts. This time, a growth scare could come from an Israeli strike on Iran that triggers a spike in crude oil prices, or it could be a more dramatic slowing in the China economy.  We are therefore cautious about chasing market prices from here.

Source: HSBC

As for Japanese equities, the rally in Tokyo stocks needs a continued weak yen and improvement in U.S. economic numbers. Given benign scenarios for both, the consensus is for a 30%-40% recovery in Japanese corporate profits in FY2012 (to March 2013), and Japanese equity strategists have successively raised their 2012 Nikkei 225 price targets to 12,000. Basically, Japan's recovery from the 2008 financial crisis is about 1 year behind that of the U.S. due to the Tohoku earthquake/tsunami disaster. Without this disaster, the Nikkei 225, like the S&P 500, would be much closer to its pre financial crisis levels, i.e., pushing for 14,000. Instead, the Nikkei 225 again threatened to fall below 8,000 as the government fumbled to get together a cohesive response to the disaster.

Source：Golden Chart

Like other equity markets, Japanese equities face the same risks from a spike in crude oil prices and a hard landing in the Chinese economy, defined as growth well below 7% PA. Templeton Emerging Marketing Group chairman Mark Mobius insists there will be no "landing" for China, i.e., it will keep growing. But Japanese exports are being double-punched by slowing demand in Euroland, first through direct exports to the region, and indirectly through reduced demand from China, whose exports have also been hit by weak demand in Euroland. Thus Japan's exports to Euroland and China have been falling YoY for the last five months. 

However, Japan actually managed a slight balance of trade surplus in February on the strength of a recovery in automobile exports to North America as global supply chains normalize after both the March 2011 Tohoku disaster and severe Thailand flooding in second-half 2011. In other words, the weakness in China and Euroland exports can be offset by a recovery in U.S. demand. In looking at the fundamentals of Japan's electronic sector vis-a-vis its automobile sector, it is clear that the automobile sector is leading the recovery, while the electronic sector remains mired in red ink. 

YoY Japanese Exports by Region

YoY Exports by Major Product: Chemicals (blue), Electronics (Green), Autos (Orange)

Further, it appears that Japanese bank stocks have finally hit bottom and have begun to break to the upside, after severely lagging both the recovery in the Nikkei 225 from November of last year, and the surge in U.S. bank stocks. As a result, there is room for significant rally (of 50% or so) in Japanese bank stocks

Nikkei Bank Index