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• Japan's economic problems

• Long term implications of Japan's decisions

• Abe's influence on the Dollar Yen

This week…

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General Advice & Risk Warning

Please note that any advice given by Invast staff is deemed to be GENERAL advice, as the information or

advice given does not take into account your particular objectives, financial situation or needs.

Therefore at all times you should consider the appropriateness of the advice before you act further.

CFDs and Forex are leveraged products and carry a high level of risk and are not suitable for everyone. You

can lose more than your initial deposit so you should ensure CFD and Forex trading meets your investment

objectives. We recommend you seek independent advice. Strategies and charts used in this presentation are

for example only. You are reminded that past performance is not indicative of future performance.

Invast Financial Services is regulated by ASIC. It's important for you to read and consider the relevant Product

Disclosure Statement and Financial Services Guide which contains details of our fees and charges before you

decide whether or not to acquire any financial products. These documents are available at www.invast.com.au

Invast Financial Services Pty Ltd ABN: 48 162 400 035. Australian Financial Services Licence No.438 283

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This week we look at the following topics:

• Japan's economic problems

• Long term implications of Japan's decisions

• Abe's influence on the Dollar Yen

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Dear Readers,

As we wrote last week, this month’s reports will be structured as follows:

Key theme 1 - Week commencing 1 December 2015: Watch closely what happens toApple shares.Key theme 2 - Week commencing 8 December 2015: Watch closely what happens toEuropean shares.Key theme 3 – Week commencing 15 December 2015: Watch closely what happens toJapan’s Nikkei.Key theme 4 & 5 – Week commencing 22 December 2015: Key energy losers & theirlenders.

Key theme 3 – Week commencing 15 December 2015: Watch closely what happens toJapan’s Nikkei.

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We wrote last week about the European economy and the need for Germany to digdeep and pull the rest of the economic zone out of a deep slumber. We spoke about thewillingness of the ECB to act and the capacity for Draghi to pursue more action in theNew Year, even though the market was starting to question his resolve. We pinpointedseveral Germany stocks, all members of the DAX30 index, which we thought had strongpositive leverage to a falling Euro against the US Dollar and lower energy prices.

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Our discussion this week is on Japan, probably in a similarsituation to Europe, but one which has now last foralmost two decades. Japan’s economic problems aren’tnew but they are important. As we write this note anelection is due to take place. We assume that Abe issuccessful by the time you read this note. The market haspriced in an Abe victory as very likely and so we don’treally see any major shocks.

Our focus is more on the long term implications of Japan’s actions and the directimpact this has on the Nikkei, which touched six year highs this year and thecontinuing depreciation in the Japanese yen – one of the most highly traded currenciesglobally.

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Our note this week is a little different in style, it contains more of an “economic focus”than usual. But we think it is very important to have a sound background into one of theworld’s largest economies. Japan has the potential to surprise on the upside of become ahuge global financial shock within the next few years. If you are trading markets, havinga firm understanding of what is occurring in Japan is paramount to your results.

Before starting our discussion on Japan this week, we would like to remind our readersthat they can always send in their feedback on our notes and analysis. We haven’treceived much feedback this year and we want to make sure you are reading these notesintently. Not everything we write is perfect but we try our best to provide you with anoverall framework around your thinking as a trader and investor. Drop through anyfeedback on our reports or requests for 2015 to support@invast.com.au.

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Japan’s recession – something to worry about?

We aren’t losing sleep over the technical recession which was recently reported afterJapan’s third quarter growth rate fell compared to expectations of a modest rise. Japanpushed through a significant increase in sales tax during the second quarter, which wasreflected in the GDP contraction, purchases and consumption was brought forward inthe first quarter which inflated the numbers. GDP for the July to September quarter wasrecently revised down to an annualised 1.9% contraction rate from the previouslyreported 1.6% annualised contraction rate.

The surprise in the third quarter in itself suggests one real quarter of negative growth. Ifthe first and second quarters were evened out, the rate of growth would have somewhatmoderated.

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Stills, it’s not positive. The next increase in the sales tax will now be pushed out and Abehas taken this to an election so that his mandate for economic reform – commonlycalled Abenomics – is reaffirmed. If economic growth contracted because of theintroduction of the sales tax, we see this as a short term blip in fixing a long termproblem. The sales tax is needed to help Japan fund its ballooning debt burden andupcoming reforms which are yet to take place. For us, the most important questions arehow much further can the debt burden grow before the markets starts to completelyfreak out.

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How much debt does Japan really have?

The numbers in isolation look scary. Since the early 1980s, the private sector has beendeleveraging (causing the sluggish growth situation) while the public sector has seen ahuge increase in its absolute debt levels. Recent estimates put Japan’s gross governmentdebt as a proportion of GDP at around 237%. But, the next figure is somewhere closer to135%, still extremely high and only likely to continue growing as quantitative easingramps up on an unforeseen scale.

The introduction of the steep sales tax announced this year is one measure in trying toaddress the debt load. It is an extremely difficult balancing act. After suffering fromyears of ongoing deflation and the horrible consequences of the Tsunami Disaster in2011, inflation finally returned in 2014 before albeit at a pace much lower than the Bankof Japan’s desired 2% level.

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According to Bloomberg “…About 15.6 percent of Japanese tax revenue goes to payinterest on this debt every year -- about the same as for the U.S. This is a moderateburden on government finances, but one that would quickly become unsustainable ifinterest rates were to spike…” We don’t see this as a short term issue as rates will onlystart to rise on inflationary pressure and inflation is nowhere near the 2% BOJ target rateyet. Inflation is also not an issue in the United States and with falling energy prices,global economies have less imported inflationary pressures before adjusting for theircurrency cross rates.

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Most economists include economists Takeo Hoshi and Takero Doi agree that Japan’sgovernment revenue would need to rise to around 40% of GDP in order to meaningfullystart addressing the debt issue. We came across this academic paper which botheconomists wrote in 2011. A lot has changed since then, but our analysis here is basedon many of their findings.

Taxes are now around 28% of Japan’s GDP, this is before government expenditures whichsees fiscal deficits currently in the order of around 8% of GDP. This explains why the salestax measure is so important and Abe needs to strike a tough balance between imposingthis and managing to increase inflation through modest rates of growth. The 12% salestax limit is only the beginning and has so far proven to be very politically difficult to sellin its entirety.

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A lower yen is the key to short term problems

Without going into a complete economic essay, we think the only real solution to Japan’seconomic problems is to continue devaluing the yen and start to push for inflation asmuch as possible, without completely blowing out the government’s balance sheetcapacity. A falling yen against major peers will not only add imported inflation butcontinue to assist key multinational conglomerates which form part of Japan’s importantexport economy. This is very similar to the situation in Europe which we spoke about lastweek.

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Image: USDJPY weekly price chart via Invast MT4 platform

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The weakness in the Yen has become a major boost for the corporate earnings of manyJapanese multinationals – these are the companies which will start to invest inresources and staff. Japan’s unemployment rate is already very low by globalcomparisons but the amount of investment intensity by the private sector is the keyissue. The risk aversion has seen bond yields slump and in turn reduce inflationaryexpectations. A windfall in export earnings could become a major boost for this spiraleffect.

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We think the Yen will continue to weaken against the US dollar for the three followingreasons:

1) Assuming Abe’s re-election, this will rubber stamp his authority to pursue his stimulusplans;2) The Bank of Japan is too far down the road to turn back;3) The US economy, aided by falling energy prices, can no longer maintain its currencyweakness and will have to start dealing with interest rate rises at some point in 2015.

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The weakness in the Yen has seen the Nikkei 225 post an 8.8% year to date return as ofthe time of writing. We estimate the Nikkei 225’s price to earnings ratio at around 26xwhich implies an earnings yield of around 3.8%. This might seem high on face value butis still attractive when compared to Japanese government 10 year bond yields at 0.40%and 30 year yields at an amazing 1.37%. In order to achieve a 2% target inflation rate,we would assume that the 10 year yield would need to at least double or risesomewhere in the order of 1% from 0.40% currently.

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Image: JP225 daily price chart via Invast MT4 platform

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There is still huge scope for earnings growth on the Nikkei 225. The chart to the left issourced through Google finance, it shows that the Japanese market might be at 6 to 7year highs this year but still considerably below the 2000 peak and way below thealmost 40,000 level touched towards the end of the 1980s.

As the yen falls and the earnings impact flows through the market, Abenomics still startto achieve the much needed traction which it set out to achieve when implemented. Wedon’t feel like there is a second chance or the prospect of Japan turning back from this.As China slows, Japan will become a larger focus point in 2015. The quarterly economicdata will start to reflect the true nature of the economy once the sales tax distortions areremoved and Abe will have a clear mandate.

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What happens in the long term to Japan’s debt levels remains to be seen. The irony ofthe BOJ is that a 2% inflation target might stimulate the economy but it will also increasethe servicing cost of debt which needs to be addressed with tighter fiscal measures,themselves a risk to the economic recovery. We’ll discuss our exact outlook for theNikkei 225 and the Yen in our 2015 outlook guide to be published at the end of January.Expect much more on this topic.

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5 Major Themes for 2015: Join the webinar to discuss these points

Invast Insights chief editor and contributing author Peter Esho will summarise hisoutlook on 5 key investment themes he believes are critical in 2015. Esho will documenthis findings based on the performance of key markets in 2014 and where he believes thebig opportunities lie next year. His presentation will focus on the following 5 themes:

Watch closely what happens to Apple shares. Watch closely what happens to European shares. Watch closely what happens to Japan’s Nikkei. Key energy losers & impact on their lenders.

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Esho is a regular contributor on CNBC, Bloomberg and host of ‘YourMoney Your Call’. His webinar will cover both the fundamental andtechnical outlook on these key themes and a basic introduction toInvast’s new DMA CFD product offering which complements MT4and other services.

This webinar is expected to fill fast. Q&A will be open straight after the presentation.Register now by visiting http://www.invast.com.au/resources/webinars.aspx.

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Go to www.invast.com.au/insights to get a complimentary 4 week trial and receive the latest insights as they are published to our live clients.

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DisclaimerPlease note that you are receiving this report complimentary from Invast Financial Services Pty Ltd(AFSL 438 283). Invast staff members may from time to time purchase securities which areincluded in this or future reports. The authors of this report may or may not be holding a positionin the securities mentioned. Please note that the information contained in this report and Invast'swebsite is of a general nature only, and does not take into account your personal circumstances,financial situation or needs. You are strongly recommended to seek professional advice beforeopening an account with us.

General Disclaimer: This newsletter contains confidential information and is intended only for theperson who downloaded it. You should not disseminate, distribute or copy this newsletter. Invastdoes not accept liability for any errors or omissions in the contents of this newsletter which ariseas a result of downloading this newsletter. This newsletter is provided for informational purposesand should not be construed as a solicitation or offer to buy or sell any financial product. InvastFinancial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).

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Risk Warning: It's important for you to read and consider the relevant Product DisclosureStatement, and any other relevant Invast Financial Services Pty Ltd documents before youdecide whether or not to acquire any financial products listed in this email. Our FinancialServices Guide contains details of our fees and charges. All these documents are available hereon our website, or you can call us on +612 8036 7555. CFDs and Foreign Exchange areleveraged products and carry a high level of risk and you can lose more than your initial depositso you should ensure CFD and Foreign Exchange trading meets your personal circumstances.

General Advice Warning: Being general advice, this newsletter does not take account of yourobjectives, financial situation or needs. Before acting on this general advice you shouldtherefore consider the appropriateness of the advice having regard to your situation. Werecommend you obtain financial, legal and taxation advice before making any financialinvestment decision.

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