Japan’s J Curve

Japan’s J Curve

Summary:

  • Japan’s trade balance and current account are on the upswing, making material strides on the J Curve.
  • One of the largest stakeholders of Japanese stocks has quietly become the Bank of Japan.
  • Monetary policy leaders from the BOJ will be meeting June 15th and 16th to discuss their next move.

Japan’s most recent affair with quantitative easing began in October of 2010 following poor economic and inflation growth after the great recession. Since then, Japan’s headline stock index, the Nikkei 225, has rallied nearly 70%; however, Japan’s quantitative easing program has far outpaced stock market growth. Specifically, The Bank of Japan’s bond buying program currently stands at 80 trillion yen per year, 2.28 times the original amount initially suggested in late 2010 of 35 trillion yen.

While stocks have responded to the Bank of Japan (BOJ), other sectors of the economy have taken some time to recover, specifically trade. According to some economic trade theory, this should be expected.

Economists define a J Curve as the upswing in a country’s current account after a successful devaluation of the local currency. The presumption is that immediately after the devaluation event, imports become more expensive for the local economy. Also in the short term, trade contracts remain little changed. These short term events lead to a slight worsening of the current account balance. This is the trough of the “J” in the below chart, location “Y”.

Article 6 - Japan's J Curve - Pic 2

In the long run, the current account will start to rise above previous levels, higher than both location “X” and “Y” on the chart above. The current account rallies due to better international pricing—driven by the more competitive domestic currency. Over time, the local currency also gets accounted for in trade deals…making export businesses marginally more attractive for the domestic economy. Finally, consumers buy fewer imported goods after the devaluation event. All these drivers help rally the current account. However, the current account is not only powered by trade. Economists define a country’s current account as the sum of exports less imports, bottom line income from firms abroad, and net currency transfers. The most material component of this formula is exports less imports, however, or trade balance. Japan’s current account and trade balance have been rallying due to realizing these macroeconomic realities.

Watching Japanese current account statistics is imperative for fundamental and macro investors. Not only is Japan the third largest economy in the world and the second largest global debt market, but the current account gives investors an uncanny snapshot of capital flows. A positive current account indicates that Japan is a net lender to the rest of the world.  For the last 21 months, Japan has managed to post positive current account numbers. Their most recent figure was actually the largest monthly surplus since 2007. Lower energy prices have certainly helped Japan in this category.

Similar to Japan’s current account, trade balance is on the upswing as well. The below charts display these figures, courtesy of Trading Economics. The firm expects these trends to continue. Using their autoregressive integrated moving average (ARIMA) model as a gauge of the future, Japan’s balance of trade and current account seem to have bottomed. Both are imperative for finding the low of the J Curve.

Japan’s Current Account

Article 6 - Japan's J Curve - Pic 3

Japan’s Balance of Trade

Article 6 - Japan's J Curve - Pic 4

Japan has relied historically on exports as an area of strength. Since 1963, Japan’s trade balance has averaged net exports of 369.34 billion yen. The depths of the J Curve were found in January of 2014, posting a record low of -2,795.04 billion yen deficit.

Japan’s trade balance and current account seem to be bottoming, but there is one issue. The J Curve assumes a devaluation event. Japan, however, is not taking this route. The BOJ has been pursuing quantitative easing, which is similar to devaluation, but takes longer to play out, as the charts above display. Devaluation is not the same as depreciation via quantitative easing, but many parallels can be drawn. Both strategies target inflation and currency levels. The BOJ is attempting to ease the yen lower, but many traders are hoping their operations will not work.

According to the U.S. Commodity Futures Trading Commission (CFTC), the majority of hedge funds and other leveraged players are long yen futures. As of the last report on May 10th, there are 65,849 open long contracts vs. 38,754 short contracts. Open interest recently flipped to a long bias after the BOJ took rates negative. Around the time of that meeting, Bloomberg broke an interesting story regarding the BOJ’s aggressive measures.

Bloomberg recently suggested that the BOJ should actually be listed as a top 10 stakeholder in nearly 90% of the Nikkei 225. Due to the BOJ’s monetary policy and extreme levels of ETF buying, the bank has oddly become a material but anonymous owner of stocks. Mysteriously, they are nowhere to be found—not having been listed in any regulatory filings or releases. The firm further estimated, according to publicly available figures, that the BOJ owns about 52% of all Japanese ETFs.

In recent news, the BOJ decided to not increase their stimulative efforts, but did buy themselves more time with a delay on their inflation goal. BOJ Governor Haruhiko Kuroda stated “time was necessary” in order to achieve their elusive 2% CPI level due to negative rates taking a bit longer to gain traction vs. other policy measures. Their revised ETA is now until the end of 2017. Should GDP continue at its current rate, the BOJ could reach their destination earlier than expected.

Growth wise, GDP just came in 140 bps above expectations. Despite the looming consumption tax increase, Japan’s economy grew 1.7% in Q1 2016. The report outlined strength in consumption, government expenditures, and trade. The lagging variable was investments. Analysis attributed this lag to the strong yen and negative rate move by the BOJ.

Economic data from Japan seems to be on the upswing from a quantitative and qualitative point of view. The BOJ has facilitated this with historic measures, but there is still work to be done. Moreover, time is needed for all these economic indicators to begin to translate into actual inflation growth. Investors should be aware that the BOJ intends to hold a Monetary Policy Meeting (MPM) on June 15th and 16th. A summary of the bank’s opinions, as discussed in the MPM, will be disclosed on June 24th.

 

Fariba Ronnasi
CEO, Elite Wealth Management

Full Disclosures: http://elitewm.com/disclosures/
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.

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