Monday, 24 September 2018

Shorting Japan

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Anthony Peters dodges Abe’s arrows, mulls Chinese data and warns of the return of private equity.

When I closed yesterday’s column with the words: “Meanwhile, I remain highly sceptical with respect to Japan, Abenomics, its little arrows and reckon that the best hedge there remains a flat book. In fact, it might be the best and cheapest short for the year.”

I did not expect to come in today to find the Nikkei nearly 400 points in the red and down 2.6% on the day. That has Japanese stocks off by around 9%, year to date.

Mind you, at 14.830 points at the time of writing, the index is still well above its early February low of 14,008 points but equally far away from its early January high of 16,121 points. I guess that, technically speaking, the index is in no man’s land but I still sense that the great enthusiasm which saw the huge rises in share values last year must be fading.

Japan has two fundamental “flaws”. The first is that it has next to no indigenous energy sources and that it must import most of what it burns. Its dash to generate electricity from nuclear had it replete with early and ageing reactor technology but the Fukushima disaster exposed the risks and, with its unhappy historical experience in mind, it is rapidly trying to distance itself from atomic power. Fact is, it can’t afford to.

The second and the one I regard as far more serious, is the demographic time bomb. This has a dual effect. On the one hand, the industry is starved of a vibrant labour force and that will not improve until the country opens its borders to immigration and on the other, an ageing population which is patently cognisant of the absence of a younger generation to fund pensions will therefore continue to save and save and not consume.

Since the day it was first announced, I regarded Prime Minister Shinzo Abe’s three-arrow policy as being doomed to fail for it promised nothing other than more of the same old failed policies, just larger. However, in Abe’s defence I would add that, had he tried to stimulate in that way while the rest of the world was economically on fire, then it might have stood a chance. To try to stimulate when the others are busily doing the same and to join the race to the bottom when burdened with the two key flaws described above was always going to prove to be an exercise in futility. I rest my case.

Chinese calendars

Meanwhile, China has us all foxed. Again harping back to yesterday’s column, I felt that we might be facing a storm in a tea cup. What I had failed to appreciate at the time was the effect of the Lunar New Year which fell this year on the first week of February. This meant that the pre-holiday boost in activity took place in January as opposed to last year when the New Year was in the second week of February and where the frantic preparatory activity was registered in the same calendar month. The year before when it all happened in January.

Thus the vagaries of the calendar helped to create significant distortions in the statistics which are, not to be forgotten, pretty dodgy at the best of times and for measuring output and trade activity these were quite obviously not the best of times.

Private equity risk

On a totally different tack and after a few years of silence on the subject, private equity is beginning to appear on my consciousness horizon again. It has broadly been keeping a low profile for the past few years when it was appreciated that loading a company with debt in order to make few corporate raiders – that’s what they were called in the wild 1980s before the more salubrious term “private equity investors” was coined – obscenely rich wasn’t really all that clever. The need for yield is gradually seeing demand or leveraged debt increase further and further.

Those in the know are quite aware that private equity has next to nothing to do with equity and everything to do with debt but Joe Sixpack thinks he understands that equity is good and that debt is bad, so a sector with “equity” in its name can’t really be all wrong, can it?

Alas, if the sector continues to grow, then it won’t be long before we get the first hostile raids on big public companies with all the issues surrounding event risk which challenged us so much at the beginning of the last decade. Any leveraged buyout precipitates a snap downgrading of outstanding debt, usually from investment grade to high-yield.

How investment-grade investors will be able to deal with forced disposal events like these without the benefit of Street liquidity has to be seen if, as and when they occur. Younger investment managers might do well to begin to read around the nearly forgotten subject of private equity event risk and start to think about how to handle it. 

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