Greed & Fear 01AUG2013 (Verbal Guidance in Japan) Word

8/22/2019 Greed & Fear 01AUG2013 (Verbal Guidance in Japan) Word

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Christopher Wood [email protected] (852) 26008516

Verbal guidance in Japan?

Singapore

The latest Federal Reserve statement has not changed anything in the continuing “tapering off”

debate with all eyes on tomorrow’s payroll data. Meanwhile, based on the revised US GDP data,

nominal GDP growth continued to slow in the first two quarters of this year. Thus, US nominal

GDP rose by 2.9%YoY in 2Q13 and a revised 3.1%YoY in 1Q13, down from 3.8%YoY in 4Q12

and an average of 4.6%YoY in 2012 (see Figure 1). This is an important point to GREED & fear

since the view here remains that government bond yields are correlated to nominal GDP

growth.

Figure 1

US nominal GDP growth

8 (%YoY)New data Old data

6

4

2

0

-2

-4

Source: US Bureau of Economic Analysis

Figure 2

US personal savings as % of disposable income

8 (%DPI) New data Old data

7

6

5

4

3

2

1

Source: US Bureau of Economic Analysis

The other point worth noting from the revision to the national accounts announced by the

Bureau of Economic Analysis (BEA) yesterday is an upward revision to the personal savings

rate. The US personal savings rates for 2012 and 1Q13 have both been revised up by 1.5pptsfrom 4.1% and 2.5% of disposable income respectively to 5.6% and 4%, while the 2Q13

savings rate is running at 4.5% (see Figure 2). This stems from a change in the way pensions

are accounted for. Before the BEA only counted cash paid into pensions. Now it includes the full

value of pensions promised, be they company pensions or government pensions. This makes it


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look like consumers have more room for manoeuvre. In reality, however, they cannot monetise

today these pension “promises”.

The Japanese stock market has so far not responded enthusiastically to the LDP’s victory in the

Upper House election on 21 July. Indeed the Topix is down 4% since the result was announced

(see Figure 3). This is in part because Prime Minister Shinzo Abe has not exactly rushed to

announce structural reforms while market focus is turning towards the potentially negative

consequences of the first part of the proposed hike in the sales tax due to be implemented in April

2014. This is because Abe has said he will make a final decision on this after seeing the growth

data for second quarter GDP. The preliminarily figures are due to be announced on 12 August and

the revised figures on 9 September.

Figure 3

Topix

1,300 Topix

1,200

1,100

1,000

900

800

700

Source: Datastream

Indeed the Nikkei reported last Saturday that Abe has asked for a second opinion on the

economic impact of raising the sales tax and will entertain various ideas for changing the timing

or size of the increase (see Nikkei article “Abe To Weigh Options For Sales Tax Hike”, 27 July

2013). According to the news article, Abe’s aides have begun assessing four options for the

sales tax hike. The first one is the plan approved by the Diet last summer, namely raising the

tax from 5% at present to 8% next April and to 10% in October 2015. A second option will

spread the hike out evenly over five years, while the third will start with a 2ppt increase

followed by three 1ppt hikes. And the last considered option is apparently to abandon the tax

hike plan altogether. It should be noted that changing the timing or size of the sales tax hike

would require new legislation.

For this and other related reasons GREED & fear agrees with CLSA’s Tokyo-based Japan

strategist Nicholas Smith (see CLSA research Benthos - The election playbook, 18 July 2013)

that the next BoJ meeting on 8 August has become important as the next potential catalyst for

a Tokyo stock market rally. This is because the market will be looking to BoJ Governor Haruhiko

Kuroda for some Flexible Mario-like verbal commitment that he will do “whatever it takes” to

move Japan out of deflation. True, Kuroda has so far done as much as anyone could reasonably

expect in terms of the BoJ’s purchases of JGBs since the annualised rate of central bank buying

is running at Y74tn compared with the commitment made on 4 April of Y50tn a year (see

Figure 4). Still in his verbal comments, Kuroda has been less convincing. Thus, he has

expressed concerns about rising JGB yields even if rising bond yields would be an inevitable

logical consequence of any successful effort to move Japan out of deflation.




Figure 4

JGBs held by the Bank of Japan

200 (Yen tn) JGBs held by the Bank of Japan BoJ target

180

160140

120

100

80

60

40

Source: CLSA, Bank of Japan

Still there is another reason why the stock market will increasingly be looking for more explicit

verbal guidance from Kuroda. This is because, as also discussed by Smith, there is a

fundamental contradiction behind so-called Abenomics. For if Abe is ostensibly committed to

moving Japan out of deflation, he is also claiming to want to pursue structural reforms, such as

labour market reform, which if implemented would initially at least be deflationary. The same is

true of the sales tax increase, long sought by the Ministry of Finance’s budget bureau, even if it

would initially have the positive, albeit artificial, impact of front-end loading demand.

This suggests that the financial markets will be looking to the central bank to make it crystal

clear verbally that it will be prepared to combat, via whatever means deemed necessary, the

potential deflationary consequences of the other aspect of Abenomics assuming, generously,

that Abe actually pushes through with real structural reforms and the proposed sales tax

increase.

How might Kuroda do this? Well, one possible way would be for the current BoJ chief to indulge

in more aggressive “forward guidance” or other “verbal manipulations” as a mean of keeping

markets on-side. What is evident is that if the BoJ chief does not venture further down this

road, in terms of making explicit the central bank’s determination to meet its 2% inflation

target in about two years, there is a growing risk of equity market disappointment. On this

point, GREED & fear’s guess is that Kuroda will eventually come to play the “verbal guidance”

game with more vigour. But there is a risk that he will have to be forced into such behaviour by

the markets.

Meanwhile, what about the actual progress made to date in defeating inflation? The BoJ’s

favoured inflation measure, core CPI excluding fresh food, did turn positive in June. But this

was primarily the result of higher electricity charges caused by the government’s continuing

failure to turn back on nuclear power plants. Thus, Japan core CPI excluding fresh food rose by

0.4%YoY in June, the biggest year-on-year rise since November 2008, while electricity prices rose

by 9.8%YoY in June, the largest increase since March 1981. By contrast, Japan’s CPI

excluding food and energy still declined by 0.2%YoY in June (see Figure 5).




Figure 5

Japan core CPI inflation and CPI excluding food and energy4

(%YoY) Japan CPI excluding food & energy

3 Japan core CPI inflation (excl. fresh food)

2

1

0

-1

-2

-3

Source: CLSA, Japan Statistics Bureau

It is worth noting again that, despite the growing cyclical optimism on global growth, Japan’s

export data in US dollar terms does not yet show any sign that the goals of Abenomics will be

helped by a significant pick-up in external demand. Indeed Japan’s export data in US dollar

terms is even weaker than the rest of Asia’s. Thus, Japanese exports declined by 12.5%YoY in

US dollar terms in June and were down 13%YoY in 2Q13. By contrast, Asia ex-Japan exports

declined by 0.4%YoY in US dollar terms in May and were up 2.8%YoY in April-May 2013 (see

Figure 6).

Figure 6

Japan export growth and Asia ex-Japan export growth (in US dollar terms)

60 (%YoY, 3mma) Japan Asia ex-Japan

40

20

0

-20

-40

-60

Source: CLSA, CEIC Data

For now, GREED & fear continues to take the view that the most likely outcome of Abenomics is

another asset inflation cycle, which will be given a further boost in due course by more verbal and

monetary intervention from the BoJ. Still it will be interesting to see in the next few months

what Abe does, or does not do, with his electoral mandate. With his popularity rating still

reasonably high at 63% (see Figure 7), if not at its highest, now is surely the time for action if

he really does believe in structural reform.




Figure 7

Approval ratings of Shinzo Abe’s cabinet vs other recent prime ministers

90 (%) Koizumi Abe (2006)Fukuda Aso

80Hatoyama Kan

70Noda Abe (2012)

60

50

40

30

20

10

0

1 2 3 4 5 6 7 8 9 10 11 12

(months in office)Source: CLSA, Nikkei polls

Meanwhile if only able to own domestic or export stocks in a Japanese equity portfolio, GREED &

fear would own domestic stocks because of the greater conviction here on asset inflation than on

external growth despite the undoubted help provided by the weaker yen and lower

breakeven points to Japanese manufacturers. This, however, means for bottom-up-orientated

investors owning inferior quality companies. This is the dilemma facing fundamental investors in

Japanese equities, as opposed to those trading in and out of “ETFs”.

Figure 8

Japan housing starts

30

20

10

0

-10

-20

-30

-40

(%YoY) Japan housing starts

Source: CLSA, Ministry of Land, Infrastructure, Transport and Tourism (MLIT)

With this preferred domestic focus in mind GREED & fear will remove an exporter from the

Japan long-only portfolio this week and include another housing company since the sector has

sold off in part on concerns that the sales tax hike may be delayed. Accordingly, the investment

in Honda Motor will be removed and replaced by an investment in Daiwa House (see Figure 21).

Meanwhile, the Ministry of Land announced yesterday a 15.3%YoY growth in June in nationwide

housing starts (see Figure 8). For more on this sector read a research note published yesterday

by CLSA’s Tokyo-based property analyst Cenk Simsek ( Japan housing - Rising momentum, 31

July 2013).




Aside from the asset inflation story, the other growing probability in Japan is long-delayed post-

earthquake reconstruction and classic LDP-style public works spending. On the subject of public

works, it is encouraging that the latest data shows that the amount of contracted public works

increased by 25.2%YoY to Y4.07tn in 2Q13, the highest level since 3Q03 (see Figure 9).

Figure 9

Japan amount of contracted public works

6 (Yen tn)

5

4

3

2

1

0

Value %YoY (RHS)(%YoY) 30

25

20

15

10

5

0

(5)

(10)

(15)(20)

(25)

Source: East Japan Construction Surety (EJCS)

Figure 10

Shanghai Composite Index

3,600 Shanghai Composite Index

3,400 200-day moving average

3,200

3,000

2,800

2,600

2,400

2,200

2,000

1,800

Source: CLSA, Bloomberg

There is no doubt that sentiment on China remains more bearish than at the start of the year as

reflected in the Shanghai Composite Index which remains 6.8% below its 200-day moving

average (see Figure 10). The latest data on China diesel demand also again highlights the

slowdown in the Chinese economy. Thus, China diesel demand declined by 0.7%YoY in 2Q13 and

is down 0.2%YoY in the first half of this year (see Figure 11).

Still this does not mean that the Chinese economy is falling apart. The residential property

market remains relatively robust. Residential volume sales in 13 large cities tracked by China

Reality Research (CRR) are still up 27%YoY in the year to 24 July and in eight tier 3 cities they are

up 39%YoY. As for the trend in prices, the CRR property price index of 120 for-sale

residential projects in 40 2nd and 3rd tier cities rose by 0.3%MoM and 4.2%YoY in June (see

Figure 12). While outstanding property loans rose by 18.1%YoY to Rmb13.56tn at the end of June, up from 16.4%YoY at the end of March (see Figure 13).



Christopher Wood

Figure 11

China diesel demand growth

25% (%YoY)

20%

15%

10%

5%

0%

-5%

-10%

-15%

Source: CLSA, CEIC Data

Figure 12

CRR Property Price Index

7% (%MoM)

6%

5%

4%

3%

2%

1%

0%

-1%

-2%

2007 2008 2009

[email protected]

China diesel demand growth

%MoM %YoY (RHS)

2010 2011 2012

(852) 26008516

(%YoY) 35%

30%

25%

20%

15%

10%

5%

0%

-5%

-10%

2013Note: Based on average selling prices at the 120 for-sale residential projects in 40+ 2nd and 3rd tier cities tracked by CRR.Source: China Reality Research (CRR)

Figure 13

Growth in China property loans outstanding

50 (%YoY) Growth in China property loans oustanding

45

40

35

30

25

20

15

10

5

0

Note: Including real estate development loans and mortgages. Source: CLSA, PBOC, CEIC Data




Yet the property market is not accelerating in a manner which suggests imminent aggressive

renewed tightening. Meanwhile, the continuing strong land acquisition by developers suggests

there is still confidence in the durability of the cycle. Thus, new land bought by 26 leading listed

developers tracked by CRR rose 63% in volume terms and 173% in value terms in June (see

CRR report Property: Land Market Update, 24 July 2013).

This picture of a China which is slowing, but not falling apart, is the message of a new column

written by head of China Reality Research, David Murphy (see The Real Deal: A clear-eyed view

of China with David Murphy, 26 July 2013). Meanwhile, the trillion dollar question remains how

committed to reform and restructuring the new PRC leadership will prove to be. The best signal

on this will be the Third Plenum of the 18 th Central Committee of the Communist Party of China

due to be held around October. But it is already evident that the new leadership is much more

committed than its predecessor. The latest evidence of this was the announcement on Sunday

in the form of a one-line statement by the National Audit Office that there will be a nationwide

audit of all levels of government debt, which presumably will focus on local government debt.

Meanwhile, the key pressure point for a return to more aggressive stimulus will be a materialpick up in unemployment. So far this has been very marginal, as noted by Murphy. Still one

evidence of contractionary pressure is that, based on the latest CRR quarterly SME survey, blue

collar income growth has slowed from 9.3%YoY to 6.6%YoY over the past quarter (see Figure

14 and CRR report SME Quarterly: 2Q13, 15 July 2013).

Figure 14

China average wage growth of factory workers

20% (%YoY)

15%

10%

5%

0%

-5%

Unskilled factory workers

Skilled/managerial workers

Note: Based on CRR’s quarterly survey of around 160 Chinese SMEs in about 60 cities. Source: CRR

If the China story this year is all about the extent to which the new leadership is ready and able to

reform the economic model, it is self-evident that the China-driven slowdown in emerging

market growth is now consensus with the latest cover of The Economist featuring precisely that

theme (“ The great deceleration”, 27 July 2013). One entirely non China-related aspect of the

emerging market deceleration has been the relatively dramatic slowdown in India, the result in

large part of a series of self-inflicted own goals.

Recent weeks have seen renewed tightening moves by the Reserve Bank of India (RBI) in stark

contrast to the easing posture which has been in place since the beginning of 2012. Thus, the

RBI increased both the Marginal Standing Facility (MSF) rate and the Bank rate by 200bp on 15

July to 10.25%. They are now 300bp above the repo rate of 7.25% (see Figure 15).

Additionally the RBI imposed a cap of 1% of deposits in the banking system, or Rs750bn, in

terms of banks’ ability to borrow from the RBI at its repo window. The central bank also

announced it would sell Rs120bn of bonds on 18 July. Then on 23 July the RBI further cut the




limit on bank borrowings from the RBI under the daily liquidity adjustment facility (LAF) from

the aggregate limit of 1% of system deposits to 0.5% of deposits for each individual bank. The

RBI also now requires banks to maintain 99% of their daily cash reserve ratio requirements as

opposed to the previous minimum of 70%.

Figure 15

Reserve Bank of India policy rates

10.5 (%)

10.0

9.5

9.0

8.5

8.0

7.5

7.0

Source: RBI, Bloomberg

Figure 16

Indian rupee against the US dollar

42

44

46

4850

52

54

56

58

60

62

Marginal Standing Facility

Repo rate

Cash reserve ratio (RHS)

Indian rupee/US$ (inverted scale)

(%) 6.5

6.0

5.5

5.0

4.5

4.0

3.5

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13


The key motive behind all these moves has been to try to shore up the rupee which had broken

through the psychologically critical Rs60/US$ level. The measures had succeeded in stabilising

the currency until Tuesday (see Figure 16). The irony here is that the currency market seems to

have sold off in response to the message conveyed by the central bank in its pre-policy meeting

macro assessment released on Monday when it stated that recent tightening measures had

provided, at best, “some breathing time” and that the tightening strategy would only succeed

“if reinforced by structural reforms to reduce the current account deficit and step up savings

and investment”.

This is a familiar refrain from the RBI and it will be interesting to see if the next RBI governor

will be more effective in applying pressure on Delhi than the current relatively battered

incumbent Duvvuri Subbarao who is due to step down in early September. Still investors shouldnot bet on it though, in GREED & fear’s view, it will be a definite positive for sentiment if the




next RBI Governor is, as expected, the current Chief Economic Advisor to the Finance Minister

and former IMF chief economist, Raghuram Rajan.

The Indian story has now become all about the outcome of the approaching general election

which has to be held by May 2014. Clearly, the stock market would most like to see a BJP-led

coalition led by Gujarat state leader Narendra Modi. For now that looks more like a possibility

than a probability due to the BJP’s lack of coalition partners. Modi’s appeal is also primarily to the

urban middle classes, not the rural masses benefitting from Congress’ populism of which the

latest example is the proposed Food Security Act, the pet scheme of Italian-born Congress leader

Sonia Gandhi.

Meanwhile, the main point to be made about the approaching election is the sheer

unpredictability of the outcome. This is evident from the release of two opinion polls over the

past week giving precisely contrasting messages, one showing rising support for the BJP, one

showing less. Thus, CNN-IBN opinion poll results published over the weekend suggest that BJP

will emerge as the largest party with about 156-164 seats in the 543-seat parliament, up from

116 seats in 2009. Congress is predicted by the same poll to lose about 70 seats from 206seats in 2009 to 131-139 seats. Then Times Now came out with another opinion poll on

Tuesday projecting that the opposition NDA coalition would win 156 seats with the BJP alone

getting only 131 seats, while the ruling UPA coalition would win 136 seats with the Congress

pegged to 119 (see Figure 17). This compared with the April poll results which projected the

BJP would win 141 seats. This, therefore, suggests that both the BJP and Congress will fall well

short of forming a government. Remember that the total number of seats required to form a

government is 272 in the 543-seat parliament.

Figure 17

Projected parliamentary seats won by BJP/Congress and allies

2009 Apr-13 poll Jul-13 poll Jul-13 poll

Party / Alliance election Times Now CNN-IBN Times Now

BJP 116 141 156-164 131

BJP allies 16 24 13-19 25

NDA 132 165 172-180 156

Congress 206 113 131-139 119

Congress allies 21 15 15-21 17

UPA 227 128 149-157 136

Source: CLSA, CNN-IBN, Times Now

Amidst this confusing picture, the key points to note are that it appears for now to be much

easier for the Congress to secure coalition partners, such as regionally focused parties, than

the BJP. While the view of CLSA’s India office is that the BJP will need to win at least 200 seats

on its own to form the next government, which compares with the 116 seats it won in 2009.

That is the challenge facing Modi. But he is definitely a very different type of Indian politician

with a track record of clean and efficient government in Gujarat. In GREED & fear’s view the

bigger the sense of crisis in India, the better his chance of winning.

Meanwhile, the risk for the stock market is that foreigners are now panicked further out of their

equity positions by the chronically weak rupee. Having bought a net US$15.1bn worth of Indianequities in the first five months of this year, foreigners have sold US$2.8bn in the past two

months. Meanwhile, CLSA’s Indian economist Rajeev Malik now forecasts that the rupee will




reach Rs65/US$ by the end of 2014 (see CLSA research Infofax Daily: India policy - Politically

correct RBI, 31 July 2013).

Figure 18

Cumulative foreign net equity investment in Indian equities

40 (US$bn)

36

32

28

24

20

16

12

8

4

0

(4)

Jan 11 Apr 11 Jul 11


India cumulative FII net equity investment

Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13

The debate on who will succeed Billyboy Ben at the Fed has picked up momentum in the media

over the past week with opponents to the Larry Summers candidacy making their concerns

very clear. Interestingly, this criticism has come as much from the Democratic left as the

Republican right. This has also raised focus on an increasingly apparent phenomenon, and one

which was the subject of a recent interesting article in the International Herald Tribune (“On

view, tensions among Democrats; Obama speech highlights a new divide on the left over

economic disparity”, 26 July 2013). That is the internal divide in the Democratic Party on

economic policies. This is because many on the left of the party are concerned that the policies

of the Obama administration have done more to help Wall Street than ordinary Americans given

the preference for bailouts under Tiny Tim, and given the lack of any compelling evidence of a

pickup in ordinary Americans’ income growth.

Aside from the issues raised over the Summers candidacy, these concerns are also shown by a

new bipartisan effort to re-establish the Glass Steagall Act which legally separated investment

banking from commercial banking. This 37-page long legislation was passed in 1933 and

repealed in 1999. GREED & fear refers to a bill brought before Congress in mid-July jointly

sponsored by Democrat Senator Elizabeth Warren, Republican Senator John McCain and two

other senators. What is interesting about the renewed Glass-Steagall debate is that the left and the

right tend to agree on the need for reform while the “moderate” centre seems most in hock to the

still ultra-powerful banking lobby. The left sees the need to reform high finance while the rightwants to remove the threat to taxpayers caused by allowing financial institutions to make

leveraged bets with federal government insured deposits.

In similar vein, the above mentioned article notes that Senator Warren is also proposing that

college students and recent graduates still burdened with the legacy of student debt should

only have to pay the same annualised interest rate for a year, as the Fed offers banks, namely

0.75% based on the Federal Reserve's discount rate.




Figure 19

US student loans held by the federal government

600 (US$bn) US student loans held by the federal government

500

400

300

200

100

0

Source: Federal Reserve - G.19 release on consumer credit

GREED & fear can easily imagine the appeal of such arguments; most particularly as federal

government-guaranteed student debt has become a meaningful number in aggregate while its

annualised growth still accounts for a large part of the overall growth in consumer debt. Thus,

outstanding student loans held by the federal government rose by 21.8%YoY to US$566bn at

the end of May, up from US$104bn at the end of 2008 (see Figure 19). While federal student

loans have increased by US$101bn in the 12 months to May, accounting for 64% of the total

increase in consumer credit of US$158bn (see Figure 20).

Figure 20

US annualised consumer credit flows

200

150

100

50

0

(50)

(100)

(150)

(200)

(250)

(US$bn,annualised)

Revolving credit

Federal student loans

Other non-revolving credit

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Source: Federal Reserve - G.19 release on consumer credit

The above sort of policy initiatives being championed by Warren also highlights why, if ordinary

Americans’ income growth does not recover soon in a meaningful way, investors should expect

political debate to move further in this direction. This would suggest a path to debt haircuts and

the like where creditors in the form of bondholders and banks take the hit. The potential threat to

municipal bondholders caused by the bankruptcy of Detroit in mid-July is another reminder of

this. The issue here is who takes the loss; bondholders or former city employees hoping their

pensions will be honoured.

So far the financial lobby has done a remarkable job of preventing debt forgiveness given itsclear culpability in the financial crisis. Still that does not mean that its lobbyists will prevail

forever. The growing threat of debt haircuts in the not too distant future also illustrates the

absurdity of the continuing “Basel” based practice of imposing arbitrary risk-weightings on




certain types of bank assets. Indeed it is extraordinary that this approach is still continued after it

had been so discredited in 2008 but, at least now, simple leverage ratios have also become part

of the discussion - as is evident from this week’s capital raising by Britain’s Barclays Bank. In

GREED & fear’s view leverage ratios should be the only part of the discussion on bank capital with

the Basel approach discarded completely.

But if that is the correct way to go it is also highly unlikely since the 0% risk-weighting on

government debt under Basel continues to incentivise banks to buy their own governments’

debt, a highly relevant point at present in the context of the Eurozone periphery.

Figure 21

Japan absolute-return long-only thematic portfolio

Theme Weight Stocks Description Weight

(%) (%)

Real Estate 29 Mitsubishi Estate real estate company 10

Mitsui Fudosan real estate company 6

Sumitomo Realty real estate company 5

Sekisui House property developer 4

Daiwa House property developer 4Autos 11 Isuzu Motors truck maker 3

Toyota Motor automaker 4

Mazda Motor automaker 4

Machinery 15 Keyence optical-sensor maker 4

Fanuc industrial robot maker 4

Nabtesco precision gear manufacturer 4

Mitsubishi Heavy heavy machinery maker 3

Gold mining 8 Sumitomo Metal Mining gold & non-ferrous metal miner 8

Consumer 23 Sugi Holdings drugstore operator 6

Tsuruha Holdings drugstore operator 6

Seven & I convenience-store operator 4

Lawson convenience-store operator 3

Avex Group music & video business 4

Airport 3 Japan Airport Terminal Haneda airport operator 3

Financials 5 Sumitomo Mitsui Trust specialist financial institution 5

Healthcare 6 Ship Healthcare medical equipment distributor 3

Nihon Kohden medical equipment manufacturer 3

Source: CLSA

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Greed & Fear 01AUG2013 (Verbal Guidance in Japan) Word

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