First of all, I’m back from hibernation. It’s been a while, but between moving, discovering the full extent of Greater China immigration rules, visiting friends and family around the world, and applying for and enrolling at an MSc in Banking and Finance, hibernation is probably not the word I would use. But, back to one of my favorite topics: Japan.
Noda finally called elections! Set your timers for December 16th! Meaning that in the middle of this soup boiled on the bones of a euro zone economy and the gutted hopes for US fiscal cliff resolution by bipartisanship, we get a dead loaf-fish thrown in for good measure… I will take the Chinese leadership transition apertif, thank you very much!
The analysis of the political situation looks something like this:
Politically, Noda is currently at best described as dead. The tax hikes are not popular, he’s been at the helm for a long-enough time to entrench the perceived ineptitude of the Japanese government following the earthquake, and the China-riots flared up on his watch. The problem is what comes next. Basically, Toro Hashimoto isn’t ready to take the stage domestically, but this election could provide an upsurge and make him a viable candidate for the next time around. Two years, anyone betting against? His policies in Osaka seem to be working well, and he does have some good ideas of localized, domestic decision-power to dismantle Tokyo-centred dysfunctionality, encouraging entrepreneurs and setting the stage for a change of attitude in Japanese society of willingness to try, take risks and seek something better than 0.72% rewards for individual investments of anything. He does carry a string of rather insensitive nationalistic opinions with respect to his North-Asian neighbors though. Shinzo Abe is likely the worst possible outcome: he advocates unlimited yen printing, corporatism at its finest, and fills it with populism and nationalism that would make Hashimoto blush. I can’t see anything good with this except for a plunging yen (hello carry currency! Let me borrow as much as I can in yen, I’ll easily finance a trip to Japan with the carry!) but policies that are unlikely to help much in making good use of it. Finally, Noda looks more like he wants to become the sacrificial lamb whose blood resolves the Japanese gridlock, which ironically has worsened it as the kingmakers work to oppose him. However, both pushing consumption tax increases of 5% phased over 3 years to achieve “nominal” inflation and joining the Obama-led Trans-Pacific Partnership are great things for Japan as a whole. His spending/borrowing ambitions on putting Japan on a more sure footing for long-term growth by promoting healthcare, childcare options and science.
Scenario analysis: The underlying assumption is that Japan is effectively both a TPP member and has higher consumption taxes at year end. Noda wins by poisoning the well over the longer term.
A) Abe wins and achieves a “LDP core” parliament with enough support from smaller parties that the LDP can govern effectively. Probability estimate: 50-60%. Yen would be likely to see a sustained plunge. Calling for the yen to reach 95-100 vs. the US dollar before the end of Q1 2013 (which is the end of the Japanese business year). This currency change is likely to be from several things: Direct Japanese capital flight out of Japan to preserve capital by companies and households alike, central bank action, deteriorating trade conditions with neighbors, and speculative pressures. I would enter long AUD/JPY on this factor alone, but consider GBP/JPY or CAD/JPY depending on the fiscal cliff and euro zone politics respectively. I would also enter into a end-June long call at the current equivalent of USD/JPY 120 in another carry currency to capture additional upside and volatility increases. Nikkei 225 at 11 000 in the base case, just from the unleashing of the printing press. Long companies with both high beta and high currency exposure, and short current high-performers and low net debt companies just from the expectation of printing.
After a period of 2 years, Japan’s future changes drastically and they hit their own version of a fiscal cliff, hard, and the DPJ regains mandate to keep working on Noda’s foundation. Very speculative however.
B) Abe’s LDP achieves a weak majority in coalition with Hashimoto as a main force for blocking proposals, giving the Osaka Mayor a deciding edge. Probability estimate: 25-30%. I see much the same problems in the short term, but would temper my forecast for the USD/JPY to around 90, and expect a much more modest Nikkei 225 of 9 000, mostly because I do not believe the printing presses will go on with the same force in this scenario, and that in the short term Japanese companies will be unable to adapt. Longer term there might be more upside driven by Hashimoto politicial and societal reform, but in the short term this is quite a bit too much to speculate on. Besides, terms of trade would likely be extremely bad. This would likely be most likely way for Hashimoto to gain significant power in the next general election.
C) Noda stages a comeback and together with the Hashimoto influence manages to create a weak coalition. Probability estimate of 10-25%, mostly because of the strength of the coalition members could vary significantly. My yen forecast is slightly more complicated here, and I just see a 10% swing either way relatively quickly. Stocks would be a great long-term investment, but we’re talking 5-10 years here and immediate effects are likely to take a long time to materialize. If Noda could use this to further entrench his current policies of reform given his new authority, create a “confident” Japan that doesn’t feel the need to be “strong” or “proud” and complete political gridlock dissolution, I think this would be the best for the country. I do not believe any of the other candidates have the same power and willingness for reform. If after an entrenchment of these policies, Noda was to be let go and Hashimoto is a more mature politician appealing to a more mature Japan with slightly less territorial disputes, I do believe that Japan has a chance, not a big one, but the best one of actually dealing politically with all its internal pressures.