Friday, 28 September 2012

Japan, where credit is leading equities...

"It is better to meet danger than to wait for it. He that is on a lee shore, and foresees a hurricane, stands out to sea and encounters a storm to avoid a shipwreck." - Charles Caleb Colton 

Back in our conversation "Saint-Elmo's fire", our good cross asset friend indicated to us an interesting correlation between the Japan Nikkei index and Japan's Itraxx 5 year CDS since the beginning of March. The index had been falling whereas at the same time, Japan's Itraxx CDS had been rising. The bottom graph indicates so far a fairly muted volatility for the Nikkei index:
As one can see from the above, the Japanese Itraxx CDS has been rising steadily (inverted in the graph for comparison purposes with the Nikkei index) while volatility has remained so far muted on the Nikkei index.

Itraxx Japan CDS climbing - source Bloomberg:

As a reminder from our conversation "Ecce Creditor" from March from Cheuvreux analyst Jolyon-Charles Montague his note "Atlas shrugged" on the 7th of March:
"Japan provides two important lessons for European investors: first, a case study of the perils of failing to achieve structural reform; second, how to invest in and trade a 20-year bear market. We conclude that for the current rally to continue beyond 2012 structural reform must be implemented, deflation averted and regulatory forbearance reversed: no small feat. It is often underappreciated that in 1989 Japan's net public debt to GDP was just 14.4% and the major driver for its explosion was a lack of tax revenue not fiscal largesse. Europe arguably is in a worse position than Japan as it has little room to raise taxes. Furthermore, Japan's government spending excluding social security and interest payments is among the lowest in the world. Given an aging population, Europe is on the verge of experiencing the same surge in social security spending."

Also in our conversation "Structural Instability" we looked at correlations between credit and equities and Japan stood out in particular. Monitoring levels of correlation in the short-term is fundamental if you are looking at adding relative value positions or if you would like using historical signals to position yourself on either credit or equities.

We believe once again credit is a leading indicator particularly when looking at Japanese equities.

Chart Volatility 6 months ATM Nikkei vs CDS ITRAXX JAPAN (50 entities versus 225 names) - source Bloomberg:
The recent Itraxx Japan roll impact on the widening of the Itraxx Japan index amounted to 20 bps of the widening move.

According to our good cross-asset friend, the correlation between the Nikkei volatility and credit spreads represented by the Itraxx Japan index has not been recently materially significant but, the widening of Japanese credit spreads cannot be ignored. In a very bullish credit environment, Japan is the only region (apart from peripheral Europe) where credit spreads are closer to the higher levels reached during the crisis of 2008/2009. This on-going weakness reflects deteriorating fundamentals for Japanese corporate companies such as Utilities suffering since Fukushima, struggling exporters courtesy of a very strong currency with private households hoarding cash, and specific companies facing difficulties such as Sharp and Sony. 
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- source CMA cds data provider.

Therefore we believe this relationship warrants close monitoring. A very important point to make is that Japanese structured products (Uridashi) are totally driving the Nikkei's volatility as long as we are in a range 8,000 / 10,000 on the Nikkei index. Also please note Itraxx Japan has 50 names versus 225 names for the Nikkei index, further investigation in the components in sectorials bias would be needed in our exercise.

The Tokyo Stock Price Index commonly known as TOPIX is tracking all domestic companies of the exchanges First Section (1669 domestic companies). We find there is no opposition between Nikkei and Topix spot prices versus credit.

From the below, and following a similar exercise / analysis, we can find a similar relationship with credit, namely a high correlation in spot prices but not in volatility.

CDX Japan / TOPIX:
Correlation at -82.24%

CDX Japan / 12 months ATM TOPIX Volatility:
Correlation at 18.94%

We can therefore conclude that our Japanese "uneasiness" or discomfort courtesy of many years of "easiness" is indicative of the growing deterioration of some Japanese corporates, namely the ones being quoted in the CDS market. Globally, Japanese corporates remain "cash" rich but nevertheless the cracks are beginning to show in relation to Japan. Japanese output fell by 1.3% in July and Japan is headed for contraction this quarter.

Japanese Sovereign CDS 5 year evolution since 2004 - source Bloomberg:

The Japanese fight against deflation goes on...

On a final note in the latest spat between China and Japan, trade wise, China looks to have the upper hand:
"Japan’s increased dependence on China for export sales gives officials in Beijing the upper hand in a territorial dispute that triggered street protests and forced Chinese units of Japanese companies to close plants. The CHART OF THE DAY compares Japan’s exports to China, the European Union and the U.S. measured in billions of yen, showing sales to China more than doubling between 2002 and 2011 as the nation became the No.1 market. Exports to America dropped by almost one third and EU demand was little changed. The lower panel tracks nominal gross domestic product of the Asian countries, with China surpassing its neighbor as the world’s second-largest economy in 2010 in dollar terms, data compiled by Bloomberg show. China’s share of Japanese exports doubled over the decade to 20 percent. By contrast, the U.S. bought about 15 percent of Japan’s exports last year, half the proportion in 2002. The shift underscores China’s clout in a fracas over control of islands called Diaoyu in Chinese and Senkaku in Japanese."  - source Bloomberg

"Every government has as much of a duty to avoid war as a ship's captain has to avoid a shipwreck." - Guy de Maupassant 

Stay tuned!

1 comment:

  1. With Japan and China's dispute, let's see if Japan would soften its side with this one for their investments' sake.


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