With the gong show occurring in Washington, it’s amazing anyone has the courage to write a blue ticket for any American assets. But we have to remember that the big long term money is slow moving. Implementing an asset shift is not something decided on a whim following one of President Trump’s tweets.
As summer comes to an end, and investment committees meet in early September, I don’t see how at the margin, America doesn’t get a downgrade from asset allocators throughout the world. The simple fact is that the much hyped Trump optimism has been sorely misplaced. He hasn’t accomplish any of his promised goals, and the recent infighting makes any progress increasingly unlikely. I don’t want to make any political judgements, I would rather just concentrate on what the chaos means to the market. Infrastructure, tax cuts – the chances of a transformative piece of legislation being passed – out the window. Trump’s supposed superb business acumen – if it ever truly existed, also vanished. And we haven’t even dealt with the potential of a debt ceiling disaster. It’s a complete shit show, and to think money managers will be standing at the door ready to invest in America is foolish. Long term money is overweight US assets, so the recent disorder will cause some serious trimming of American securities.
Now don’t mistake my analysis as an “end of the world – we are about to collapse” doomsday call. I just think it might be a good time to think about selling some US names, and maybe have a look at some other equity markets.
I am going to toss an idea out there that is sure to gather a lot of cynical smirks, but hear me out. The Federal Reserve is desperately trying to be the first Central Bank to actually shrink their balance sheet after an extensive quantitative easing program. At the same time, the ECB has been preparing the market for a tapering of their QE program. But do you know who is still balls to the wall printing? The Bank of Japan.
Abeconomics is still in full force. The Bank of Japan is still expanding their balance sheet like mad. And although many pundits are skeptical of Prime Minister Abe’s chances of being re-elected in the upcoming elections, and see nothing but risks, I am not as pessimistic.
I don’t think the Japanese people will reverse Abeconomics. Sure, the hedge fund gurus will all tell you what a disaster it’s being, but I just don’t see it.
Have a look at Japan’s nominal GDP.
This is a chart of GDP for Pete’s sake. It isn’t supposed to go sideways for a decade and then head downward from there. That sort of limited growth is a disaster for an economy. No wonder Prime Minister Abe was elected with the mandate to implement radical changes. They were needed.
And yeah, I get it. This was at the cost of a tremendous increase in debt. I don’t believe for one second that this debt will repaid in real terms, but let’s face it, I don’t think that much of the developed world governments’ debts will ever be money good (at least not in real terms). You can sit around and bemoan the absurdity of the situation, or you can accept that Central Banks will keep printing until the bond market takes the keys away (as my favourite skeptic Bill Fleckenstein likes to say). Right now there are zero signs that bond markets are prepared to revolt, so why anyone thinks the printing will stop is beyond me.
And no one is more all-in on extreme monetary easing than Japan. There is no going back. Japan needs to keep printing until their economy reaches escape velocity, otherwise they will fall back into their deflationary balance sheet recession. Although Western market strategists haven’t accepted this fact, the Japanese have.
Rightly or wrongly, Abeconomics will continue until the Japanese economy explodes in an incendiary inflationary fireball. They are the least likely to take their foot off the gas, so why not join them instead of fighting?
I am going to cheat a little, but I couldn’t help it. Have a look at this long term chart of the Japanese Nikkei Stock Index.
It’s not really fair as the 1980’s bubble was so egregious, it makes the recent rise seem piddly.
Part of the BoJ’s Quantitative Easing program is buying equity ETFs. I am sure you have seen all the frantic warnings about how the BoJ owns X% of the ETFs outstanding. Well, this argument is disingenuous as it is massively dependent on the popularity of Japanese ETFs. If there is little outside investor interest in owning equities in ETF form, then the percentage of ETFs that the BoJ owns will be higher. What is more appropriate is to examine the percentage of the market cap of the underlying equities that the BoJ owns. And by that measure, it is quite less disturbing.
Regardless, given the BoJ’s buying, I expected the larger cap Japanese equities to be outperforming. After all, they are the biggest beneficiaries of the balance sheet expansion.
However, much to my surprise, this is not the case. Here are the total returns for the Nikkei (large cap), the TOPIX (broad based), the MOTHERS (small cap) and finally, the JOF (US listed small cap fund – denominated in Yen to keep it fair) since the introduction of Abeconomics.
As you can see, the Nikkei and TOPIX both returned approximately 12.5%, but the MOTHERS and the JOF were both north of 15%.
The BoJ isn’t buying small cap stocks, yet the small caps are outperforming. Maybe the Japanese economy is doing better than most strategists believe.
If you are interested in playing this small cap sector of the Japanese equity market, have a look at JOF. It is a small cap fund that at one point traded at a premium, but with the apathy for all things Japanese, has drifted down to a discount.
I can already hear the cries of disdain of how I am buying the country whose long term financial prospects are the dimmest. Yeah, yeah, I know. Japan’s demographics are terrible. Their debt to GDP is mind numbingly large. It certainly appears as if their ability to grow is hampered by many handicaps.
But since when have fundamentals mattered? Everyone complains that Central Banks have made a mockery of markets, but then they spend their time fading them. Why not just pick the most aggressive Central Bank and go with it?
And what better time to jump aboard the Japanese monetary madness than when the bloom has come off the US rose?
But wait… Doesn’t part of the recent problems with the US have to do with North Korea? And won’t that be bad for Japan? Yup – you betcha. War in Korea would definitely not be bullish for Japan.
Yet I take comfort in that my favourite contrary indicator (no, not Gartman) has been forecasting war for quite some time. George Friedman, formerly from Stratfor, has been predicting that the US would be headed to war with North Korea since this spring. Here’s George giving an interview where he explains his views. And if you want more, here is a piece he wrote outlining his position. Sure sounds scary, huh?
Well, I have learned my lesson and will not be caught again listening to George. In fact, I think he is one of the best fades on the board.
Don’t believe me? Well, maybe you should go read his book – it seems especially appropriate given that I am discussing going long Japan.
I hate to admit it, but Steve Bannon’s recent comments about North Korea made a whole lot more sense.
Contrary to Trump’s threat of fire and fury, Bannon said: “There’s no military solution [to North Korea’s nuclear threats], forget it. Until somebody solves the part of the equation that shows me that ten million people in Seoul don’t die in the first 30 minutes from conventional weapons, I don’t know what you’re talking about, there’s no military solution here, they got us.”
My guess is that Trump’s bluster about North Korea will prove just as effective as his boasts about passing a yuuuuge health care bill. It’s tough to take this view, as I will look like an idiot if I am wrong, but I think the correct bet is to assume the North Korea situation is just two large leashed dogs barking at each other.
The US is not going to war with the North Koreans, but the American government is a mess, and chances are that Trump is now a lame duck President. Little will happen, and at the margin, investors will quietly head for the exit. Whereas the US seemed to have an incessant bid over the past couple of quarters, I suspect that will change to loads of overhead supply ready to plug any decent rally.
I was hesitant to write this piece today because US stocks had such a terrible day yesterday. And although I am medium term bearish on American risk assets, from a short term perspective, we are due for a bounce.
Over the years I have learned the hard way about getting bearish on stocks after big down days. And I stumbled upon this great method of stopping from getting full blown bearish into the hole.
If you watch the Bollinger Band of the QQQ ETF, and change the default settings to a length of 10 and a standard deviation of 1.5, I have found that any day that the ETF closes below the bottom part of the band, it is time to cover all your shorts, and even think about getting long.
I will write this strategy up properly sometime in the future, but I wanted you to know, it triggered last night (after triggering last week when many pundits got wildly bearish). Click on the chart above and have a look more closely at the trading. The days when it closes below the band, you don’t want to be getting bearish. Trust me that the days in the past where it has triggered have felt awful. If you were trading on emotion, you would be hitting bids all over the place. But I guess that is why it works (most of the time). Now maybe this time it will be wrong. I have learned to never say never. Yet I think getting bearish in here is the wrong bet from a short term trading perspective.
Thanks for reading and have a great weekend,