The Paradox of Japan & It's Implications

You may have read this in the recent headlines:

JAPANESE STOCK MARKET SOARS!

The headlines practically caught the attention of every Based investors in the world and suddenly, Japan seems to be the new China/India as every other articles are promoting the potential of the Japanese stock market and the amount still to be made. Well, that might be true for the domestic investors but the rise in the Nikkei 225 may not benefit foreign investors at all.

Bank of Japan governor Haruhiko Kuroda
Photograph: REUTERS/Toru Hanai

Background

Haruhiko Kuroda, the new Bank of Japan governor embarked on an aggressive monetary easing policy in order to end the long standing issue with deflation, faced by Japan over the last 2 decades. The relatively expensive Yen has made global leaders such as Sony, Panasonic and Sharp uncompetitive, losing out to the cheaper technology hubs such as South Korea and Taiwan. Major Japanese MNC has been announcing losses for the past few years as the recession in the Western economies and weaker USD/Euro take a toll on the appetite for Japan made product. At the same time, the rise of new innovative companies, such as Apple, Samsung, HTC and ASUS, have been taking away huge market shares from the Japanese technology giants as they failed to keep up with the global technology curve. Taking a cue from the Chairman of US Federal Bank, Ben Benarke and President of the Europe Central Bank, Mario Draghi, Kuroda is going to inject a huge flood of money into the market, hoping to jumpstart the malaise Japanese economy.  Since than, the Nikkei 225 has jumped almost 58% since 2012 June, when the Euro Financial crisis as at its peak. However, on the flip side, the Yen has depreciated against SGD by more than 30%.

Japanese Stock Market Soars!

Yen tumbles against SGD. Good time to visit Japan if you do not care about the radiation!

Implications of Investing in the Japanese Stock Market

How much would you have made if you have invested a year ago, after taking into the consideration of the fall of the Yen against SGD? You will have made an average of 7% since last year. Doesn't seem too fantastic after the currency swap. The trend of the falling Yen and rising Japanese stock market will continue and this will create an almost zero sum game for Singapore investor at the end of the day. We are better off investing in regions whereby there is a potential for both currency and stock market appreciation. 

So if you are asking me if we should allocate a portion to the Japanese stock market? 

My answer will be, "There are better opportunities around than trying to buy into a market with 2 very volatile variables." 

The Ripple Effect

What I am more concern is the ripple effect that will happen due to the aggressive easing of the BOJ. How will this affect other economies? Will Singapore see a fallout from their easing? The act of depressing your currency is essentially, an act of "beggar thy neighbor" policy, with no real improvement in productivity. It will definitely cause quite a few lasting implication if the weak Yen is here to stay. 

1) Decreased Capital Injection to Emerging Markets

We have seen a backflow of investment capital back to United States as it becomes cheaper to set up factories and plants due to the falling USD and wages after the US Financial crisis. It will be similar for Japan. Major Japanese outsourcing centers such as Thailand, Vietnam, India and Malaysia will see a slowdown in FDI from Japanese firms as the cost of investing in Japan comes down relatively due to the sharp depreciation in Yen.

Conclusion: -1 for Japanese Outsourcing centers

2) Increased Domestic Demand and Investment Dollars

If the whatever Kuroda is planning, begins to work, the Japanese economy might rejuvenate and domestic demand might rise again, benefiting the capital markets around the world. Recall the roaring 80s when Japanese investors travel around the world, buying up every prime foreign properties they can lay their hands on? That might happen again. This development will also benefit local Japanese corporations as it becomes more expensive to spend money overseas and Japanese will prefer to shop domestically rather than looking for cheap deals in China. Financial hubs like Singapore and Hong Kong might see another wave of hot money, right after the Chinese, Indian and Indonesian Hot Money fever.

Conclusion: +1 for Global Capital Markets & Japanese corporations.

3) Triple Whammy for Export Oriented Economies

Even with the stagnant Japanese economy, the land of the rising sun still remains as one of the key markets for exporters around the world. The falling USD and EUR has hit many export oriented economies as the slim margins of manufacturers are wipe out by the sharp depreciation in these key markets. With the sharp drop of the Japanese YEN, it will hit the manufacturing hubs around the world badly. The decreased buying power of the Americans, Europeans and Japanese due to the economic weakness of their home countries, and depreciation in their currencies may lead to a decline in manufacturing in many of those countries that adopted a export oriented model. Although Singapore has been restructuring to move away from too reliant on manufacturing in the last few years, manufacturing still make up the core components of our GDP and will definitely suffer in that aspect too. Unless the new consumers from emerging markets are able to occupy the vacuum in global spending quickly, we might see a decline of our manufacturing regionally for a period of time

Conclusion: -1 for Manufacturing in Emerging Markets  

Some Conclusion

In short, and point form which every reader loves:

1) Capital markets around the world will benefit as Japanese look abroad to protect their money from falling YEN. US stock market will get a boost from Japanese inflow. Emerging Markets might not benefit much as Japanese investor will primary invest in their soaring stock market and the US stock market which they are more comfortable and familiar with.The relatively strong USD helps too!

2) Economies of major outsourcing centers will start to suffer. Thailand is one of the biggest outsourcing center for Japanese companies. However, Japanese will not shut down the infrastructure that they spend millions to set up immediately. The impact might come later is the low YEN persist

3) Countries with huge exports to Japan will suffer. Manufacturers with large exposure to the Japanese market will suffer immediately as their profit margins shrink drastically. Avoid them.

Portfolio Updates

Most of you should have transited to the more conservative portfolio. There are currently many potential catalysts for a potential correction again. Bird flu, North Korea, US economic data, Cyprus and friends. I do not know which one will be the one that breaks the back of the current market rally but the storm clouds seem to be gathering.

Here is the monthly report for our portfolio and funds performance below: