Saturday, 16 March 2013

Japan - the rise of the Kagemusha

KAGEMUSHA = "Man who pulls the strings or exerts influence behind the scene"
- Source(s): Japanese-English dictionary.

Looking at the meteoric rise of the Japanese Yen versus the US Dollar in conjunction with a rising Nikkei index and receding credit spreads, with the latest endorsement of Mr Kuroda for the Bank of Japan governor and with Mr Iwata and Mr Nakaso for deputy governor, we could not resist but to use a reference to probably one of our most favorites films of all time, namely Kagemusha, by the legendary film director Akira Kurosawa.

In Japanese, "Kagemusha" is a term used to denote a political decoy. While the movie is set in the Sengoku period of Japanese history, it tells the story of a lower-class criminal who is taught to impersonate a dying warlord in order to dissuade opposing lords from attacking the newly vulnerable clan. Looking at the growing vulnerabilities of Japan, we wonder if the very aggressive Japanese quantitative stance, is not used as a deterring policy to dissuade speculators from attacking it or merely an internal political ploy relating to the upcoming upper elections in July, or if there is more to it.

As we have argued in our conversation "If at first you don't succeed":
"Looking at Prime Minister Shinzo Abe's first major policy initiative to end deflation and "boost" growth by announcing a cool 10.3 trillion yen fiscal (USD 116 billion dollars for now...) "stimulus" program, we could not resist but refer to W.E. Hickson's proverb which became colloquial "If at first you don't succeed".In a "Central Banks" world dominated by the "Sorcerer's apprentice" aka Dr Ben Bernanke and our "Generous Gambler" aka Mario Draghi, with impeding July elections in Japan, Abe's "fiscal alkaloid" shot, is no doubt politically motivated in order for the Liberal Democratic Party to gather support ("rising asset prices") before the upper elections in July." 

In Japan, courtesy of "Abenomics" we do have "lift-off in risky assets" or "Risk-On" that is; as indicated in the below graph we have been monitoring, displaying the USD/JPY exchange rate, the Nikkei index and the credit risk Itraxx Japan CDS spread (inverted) - source Bloomberg:

Not only has the "Kagemusha" managed to lift risky assets, but he also has managed to reduce the perception of risk in credit spreads as indicated by the significant fall in credit spreads for many Japanese companies as displayed in the below graph from CMA part of S&P Capital IQ:
Exporters from Toyota Motor Corp. to Nintendo Co.  have all raised their profit forecasts boosted by  a yen that has slumped nearly 16% against the dollar since mid-November, which is increasing the value of their overseas sales. In fact car manufacturer Toyota is seeing a windfall from the falling yen as reported by Keith Naughton and Craig Trudell in Bloomberg in their article from the 12th of March entitled - Toyota Boosted by Yen Detroit Sees as $5,700-Per-Car Bonus:

"Toyota Motor Corp., which last year overtook General Motors Co. to become the world’s largest automaker even as its profit margins lagged behind the industry, is riding a weakening yen that has Detroit executives concerned.
The yen has fallen 17 percent against the dollar since Oct. 31 as Shinzo Abe, who became Japan’s prime minister in December, advocated for the decline to improve his country’s economy. The currency’s slide gives Toyota and other Japanese automakers a financial gain on every car, which they can use to cut prices, boost ads and improve products. Morgan Stanley estimates the currency boost at $1,500 per car, while the Detroit automakers contend the figure is $5,700 per vehicle.
“We’re concerned about what the long-term ramifications are,” Joe Hinrichs, Ford Motor Co.’s North American chief, said last month at a Cleveland engine factory the automaker is expanding. “Our workers and our businesses should not be disadvantaged by governments intervening in currencies.”
Asked about the swooning yen last week at the Geneva Motor Show, Sergio Marchionne, chief executive officer of Chrysler Group LLC and Fiat SpA, told Bloomberg Television: “We didn’t need this, to put it bluntly. It’s going to make life tougher.”
The yen’s impact is already falling to the bottom line. Toyota last month raised its profit forecast by 10 percent for the fiscal year ending March 31, to 860 billion yen ($9 billion), a five-year high. That would more than double the previous year’s profit and signal a complete comeback from the global recalls and 2011 Japanese earthquake that shook Toyota’s standing as a leader in earnings, sales and quality." - source Bloomberg.

Not only Toyota is reaping the benefits from a boost in exports from a falling yen but its employees too are benefiting from increased bonuses as indicated by Bloomberg:
"The CHART OF THE DAY shows bonuses in 2012 and this year for workers at Toyota, Honda Motor Co., Nissan Motor Co., Hitachi Ltd. and Mitsubishi Heavy Industries Ltd. The world’s largest automaker agreed yesterday to the proposal by its union for a 2013 average bonus of about 2.05 million yen ($21,375) per employee, or about 5.9 months of base salary, the most in five years. Honda raised its bonus to 5.9 months from 5 months a year earlier, according to data compiled by Bloomberg. Japanese exporters are paying higher bonuses after the yen weakened to its lowest level against the dollar since August 2009. Abe called for business leaders’ help in fighting deflation that’s persisted more than a decade, and last month asked companies to raise salaries as part of annual wage negotiations with unions."  - source Bloomberg.

On top of that, as indicated by the weekly inflows report from Bank of America Merrill Lynch, this week has seen record inflows in Japan equity funds:
Record $2.0bn inflows to Japan equity funds (since 2002 in absolute terms and 
8 straight weeks).
 On the other hand, appetite for EM equity funds beginning to fade ($0.5bn redemptions) after 24 straight weeks of inflows." - source Bank of America Merrill Lynch, The Flow Show, 14th of March 2013.

Japanese equities have returned 13.1% in the past three months, making fourth spot, while Greece equities have returned 27.4% and taken the number one spot (no surprise there for us, after all there is life and value after default...).

And if you had read our January conversation "If at first you don't succeed" you would not be surprise by the performance:
"One could as well play Japan equities more aggressively by buying Japanese bank stocks given that the recovery in stock prices will lift the value of the Japanese banks' equity investments and will substantially reduce their impairment losses they have been booking in their regular YTD results. We told you this several times, but, remember, a bank is a leverage play on the economy, it is the second derivative of a sovereign. As we indicated in the "Fabian Strategy", the big beneficiaries of the "magic tricks" in 2012 have been European Banks. Could the big beneficiaries of 2013 be the Japanese banks? One has to wonder..."

In relation to our January call on Japanese bank stocks, we have long argued that a bank, are more than a beta play. Given Japan returned to growth in the fourth quarter with an annualized GDP growth of 0.2% in the three months through December compared to an expected 0.4% contraction,(bolstering the Kagemusha's campaign in ending 15 years of deflation), we thought playing Japanese financials was not a bad idea after all. In fact we are not the only ones to think about this, as Deutsche Bank's Yoshinobu Yamada recent note on the Japanese Banking sector on the 8th March entitled - Time to revisit "common sense", has been validating our views. Domo arigato!
"A turning point for trends Investors that are not positive on Japanese banks offer common sense reasons built up over the past several years, namely the sustained downtrend in domestic lending and loan spreads. This perspective holds that even as value plays, Japanese banks are not appropriate as long-term holdings without prospects for growth. However, we think recent macroeconomic data indicates that the time has come to reconsider this "common sense"." - source Deutsche Bank.

We hate sounding like a broken record but, no credit, no loan growth, no loan growth, no economic growth and no reduction of aforementioned budget deficits (our case for Europe...), but in the case of Japan we beg to slightly differ and Deutsche Bank's note is indicating the following in relation to credit growth:
"Lending growth at major banks picking up pace:
According to the Principal Figures of Financial Institutions (preliminary) released by the BoJ on the 8th, the domestic average lending balance at all banks rose 1.9% YoY in February to a total of ¥402.4trn (figure below).
Growth has been gradually accelerating since turning positive in November 2011, increasing to 1.4% in December 2012, and 1.6% in January 2013. City banks (major banks) are the category attracting attention. Though lending growth turned positive only in December 2012, lagging all banks by about a year, it improved to 1.1% by February. After the Lehman Shock in September 2008, lending at city banks increased as they became an alternative to the CP market, but turned negative in September 2009 and fell -4.7% by Nov-Dec 2010. We think recent lending growth for both major and regional banks is primarily due to residential mortgages and loans to large companies, while loans for SMEs continue decreasing. Many observers hold that lending demand for large companies is not related to economic recovery factors, due to recent increases in loans to power companies and M&A related. However, if deflation turns to inflation, it will make sense for large companies to use leverage. Though this does not mean lending demand in Japan is surging, we think it at least indicates a need to revise the common sense notion that domestic lending is on a sustained downtrend." - source Deutsche Bank

But one might wonder if boosting employees bonuses and the recent surge in Japanese lending will be enough to defeat the deflationary illness which has been plaguing Japan as indicated in this Bloomberg graph:
"The most lending by Japanese banks since May 2009, fueled by record liquidity, has yet to reverse
more than a decade of deflation, underscoring the challenge facing the next Bank of Japan governor.
“Just expanding the injection of money won’t help,” said Masamichi Adachi, senior economist at JP Morgan Securities Asia in Tokyo and a former BOJ official. The next governor needs to show how he’ll improve the transmission mechanism by which extra monetary easing translates into rising prices, he said.
 The CHART OF THE DAY tracks how the gauge of consumer prices excluding fresh food and energy has been negative every month since January 2009, even as M2 money supply rose to a record. Meanwhile, bank lending excluding trusts in January rose to the most in 3-1/2 years, data compiled by Bloomberg show." - source Bloomberg.

While in the aforementioned movie, the Kagemusha successfully fooled concubines and grandson by impersonating his daimyo Takeda Shingen, in a fit of overconfidence, he attempted to ride Shingen's spirited horse.  He fell off, and, those who rushed to help him saw that he did not have their lord's battle scars, and was finally revealed as an impostor. 

Looking at the growing current account for Japan has reported by Bloomberg in Japan Returned to Growth in Fourth Quarter in Boost for Abe, one can wonder if eventually this Kagemusha's strategy will successfully reverse Japanese woes:
The current account recorded a third monthly deficit in  
January after a 4.7 trillion yen surplus last year, the smallest 
in comparable data that goes back to 1985. We expect the current account to continue deteriorating as rapid population aging reduces saving rates and prompts the country to draw down on its net foreign assets, Izumi Devalier, a Japan economist at HSBC Holdings Plc in Hong Kong, said in a research report this week. This ‘‘will have significant ramifications for Japan’s ability to continue funding its ballooning deficits domestically.’’ - source Bloomberg

Eventually, the Takeda clan, behind the Kagemusha plot, is completely destroyed at the battle of Nagashino in 1575. At the end of the film, the thief used as a decoy, the Kagemusha, witnessed the battle and at its end he is the last one to hold up the Takeda banner. In a final show of loyalty, he takes up a lance and makes a futile charge against Oda's fortifications, ultimately dying for the Takeda clan. The final image is of the Kagemusha's bullet-riddled body being washed away down a river, next to the flag of the Takeda clan but, that's another story...

"If you keep your sword drawn and wield it about then no one will dare approach you and you will have no allies. But if you never draw it, it will dull and rust and people will assume that you are feeble." - Hagakure, The Book of the Samurai, Yamamoto Tsunetomo.

Stay tuned!

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