It may be the start of a New Year, the start 2015, but that doesn't seem to usher new life into the Land of The Setting Sun. Just after Christmas in 2014, we penned down the sheer demise of the Japanese economy as prices slipped yet further, but we revealed the real stunner to be real wage growth, or in Japan's case, real wage shrinkage. Readers should know by now how we feel about Japan, and how utterly deep the country has been digging into quicksand. It is on one hand a little sad to see a once great imperial nation slip into the shadows, but it is sheer comical to see its central planners (Abe, Kuroda et al) engage in fancy polices which are but a nostrum.
We thought the string of surprises would end there for 2014, but it didn't. Those cheeky Japanese had to pull one last hare out of its hat, and on New Year's Eve of all times. That was technically no surprise to us because it was to be expected. It just proves the title of this piece, that Japan is literally dying, day by day. Not an economic death, but a mortal death.
Highest Number Of Deaths; Lowest Number Of Births
Japan's Health Ministry reported on New Year's Eve that the country saw 1.001mn births and 1.27mn deaths in 2014. Births were 9,000 lower than in 2013. Even taken by themselves, these 2 statistics are significant in highlighting a key nail in Japan's coffin: its population is shrinking. If a country experiences a shrinking population, not because of migration or a plague, but because of a demographic trend, it is indeed very safe to say that the country is in decline.
When we look at data, we never look at a single set. So when taken into proper context as the following chart highlights, we realize that at 1.001mn, 2014 had the lowest births of any year so far; and at 1.27mn deaths, Japan had the higher number of deaths on record. This means the birth-death gap is not only negative, but by the largest negative in history. The trend in both directions shows no sign of turning, so continue to expect the expected going forward.
There are no shortage of extrapolations, all of which paint almost the same picture of a greying population without the ability of a productive demographic to reproduce at the current replacement level. As aging baby boomers slip into retirement and eventually pass on, the onus of a shrinking population and an economy with little competitiveness to the table should be enough to make one shrivel in cowardice, even when being some 35 years ahead of those predictions.
The current Administration of Shinzo Abe inevitably takes this age old problem into account when campaigning and winning over the population's popularity. Japanese politics is quite literally a game over which party spins the nicest and fairest tale on the fate of Japan's demography. But whatever jawboning politicians may utter from the start of 2015, the hard and cold facts don't change.
Home prices although in a 25-year bear market, have failed to stimulate child bearing by younger families. Tokyo remains one of the world's most densely populated cities. We feel it first hand being in Singapore, which is also extremely densely populated. Home affordability has always been an issue for young families in these cities. However, effects are more pronounced for Japan because of its fragile economy, always teetering on the edge of recession (4 recessions in the last 5 years and currently in one).
Lower child bearing rates are a secular trend amongst the developed nations and isn't exclusive to Japan alone. Countries like Germany, Britain, Singapore, Switzerland, and to some extent America are reeling from the effects of the general unwillingness to bear children. People are getting married at older ages, even so they tend to wait longer before choosing to conceive a child, and even tent the number of conceptions averages lower than the long term historical averages.
Without delving too far off topic, here are some of the commentary from news sources. The BBC was first to break the story:
The story doesn't improve with the Financial Times coming up with pretty depressing extrapolations. Such are the facts that the surmounts the nation:
More Than Just Demographic Issues
We want readers to understand that japan is not only facing a long-term demographic problem, but also structural issues, some of which are more immediate than others. Although we have laid down a very comprehensive primer on the issues Japan faces, albeit almost 3 years ago; the relevance of said 3-year-old content proves how prevalent these problems are to Japan. Not all chickens have come home to roost yet, and we suspect what has been a slow trickle in the past will subsequently escalate into a more sizable flow and ultimately unleash the torrent of malaise that has been kept being the dam for more than years now.
As much as we wish to write another missive about the state of affairs in Japan, we just do not have the time to revisit topics that have been already been extensively covered in the past. New meat on the same old bones, as they say. What we can tell our readers with good confidence, is that as long as the BoJ and the Japanese government remain predicated on fixing leaking pipes and a sealed pressure cooker with duck tape, problems will not be fixed and will all come cascading down once enough time has elapsed.
This coming Thursday, 23 June 2016, the United Kingdom will vote on a historical referendum deciding on the status of its European Union (EU) membership. For the last 2 years since 2014, the UK parliament, led by acting Prime Minister David Cameron have promised a public referendum on Britian's EU membership. Britain's relationship with Europe has always been one of contention, and many have long been awaiting this once in a generational lifetime opportunity to voice their opinions through the democracy of a vote.
The global financial markets have also been eying this key event risk for some time, and since events have heated up recently as we enter the final week before the ballots are cast, there has never been a more important 4 days for English markets (that's including the pound sterling, GBP) since the "Black Wednesday" of 1992 , the day the Bank of England was broken by the markets.
We are not usually pessimists but when we see the writing on the wall getting bold redder each week that passes, we can't help but to take serious note. Just last week, we warned readers that markets might be about to get nastily volatile during the summer. So far so bad. May hasn't started well at all. The S&P 500, as of the week ending this past Friday, posted its first 3-week losing streak since January.
Recent macro developments both in the U.S. and elsewhere have however strengthened the bearish case for risk, in our opinion. It might have reached a point where downside skews in risks make a derisking maneuver potentially more rewarding than chasing beta.
As such, we have shifted our bias to the short side of risk. The positions in our portfolio (which we keep private) have partially reflected this change in view and will continue to do so as the situation evolves.
It is a known fact that credit cycles often lead business and economic cycles. It makes sense on paper and even more sense in practice. This is a subject that we havehardly yet touched on, but will be doing so in this piece. For a majority of the investing community, the topic on credit cycles remain much of a novelty.
As of March 2016, total default volumes on HY bonds (high yield) and institutional loans in the U.S. hit a 6-year peak of approximately $16.2bn, almost half that seen in the entire of 2015. Just this past week alone, we saw at least 4 corporate defaults with 3 in the energy sector.
So far in 2016 (Jan-Mar) default volumes have reached a jaw dropping $32.4bn. To put this in context, 2015's default volume (which was already abnormally high) stood at $37.7bn. If this trend were to continue through 2Q and beyond, we are talking about a full-fledged wave of defaults.
For the first 3 and a half months that have already elapsed in 2016, no asset class has seen the consistent volatility that currencies have. Central banking has been busy, almost too busy, all while the macro fundamental landscape has hardly moved an inch. With all that drama, noise, and play in monetary policies throughout the global economy, one would expect sizable trends in FX. But that hasn't been the case.
For instance, when the ECB first lowered its deposit rate to zero back in the first half of 2015, that sparked a major bear market in the euro, and a bull market in risk assets including euro bonds. When the Fed announced it planned to gradually taper QE3 and eventually end it late in 2014, the U.S. dollar began building up into what we now recognize as one of the most fervent dollar bull markets ever.
Monetary policy divergences used to herald the alpha and omega of huge trends. But not today.
Now, thanks to a comprehensive piece by Bank of America Merrill Lynch, we can provide readers with a glimps of what might be the next big trend in FX.
Last week, Bloomberg broke a story which greatly fascinated us. It involves a mysterious "specter", one which we have no clue about, flooding the Turkish stock exchanges with massive buy orders, massive to the tune of some $450mn in a single day.
Turkish locals refer to this entity (whoever or whatever it is) as "the dude", crowning the figure with an amphibious demeanor worth of a chapter in Slenderman. We have no idea, absolutely no idea who or what "the dude" is, how it specifically operates, and what its motives are for slamming a relatively illiquid market with order sizes so large, they scare the living daylights out of even the staunchest of permabears.
All we know is that local authorities have been rattled, investors shaken off to the sidelines, and a stock market that is now a stellar outperformer in the emerging market (EM) space. Even with the gruesome terror attacks in Istanbul over the weekends, an attack which has killed at least 37 people the last we checked, the Borsa Istanbul Index has now rallied for the 9th straight day.
That's right, we need the U.S. dollar to be BOTH strong AND weak at the same time for continued upside in equities. Much has been said about the greenback ever since the end of the Fed's QE3 program in late 2014. It was then all about king dollar leading up to the Fed's first (in a decade) rate hike in December 2015. Speculators kept piling in on the the freight express train that was the long dollar trade du jour, creating what has become one of the most crowded trades in modern history.
It's likely going to be a tug of war between these forces we've highlighted in this piece. Again, we make no predictions as to direction. We do however expect this conundrum to continue until a novel catalyst emerges that alters the way market participants trade and position. What this novel catalyst is, we don't know.
This conundrum is big, as we shall explain below.
The top 0.01% of the erudite elites control more than 60% of the world's wealth, while the 80% of us have a collective net worth less than the top 1% of society. In a world decorated with such gaping inequalities, risk and opportunities present themselves. While problems may be plentiful, there are also long term opportunities to capitalize on the mother of all trends: A globally aging demographic.
Which is what Janus Capital's Bill Gross, well revered as being called the "Bond King", is driving at in his latest investment outlook. In the race between the tortoise and the hare, the former analogous to a gradually aging population, the latter to technological advancements, the tortoise eventually catches up. Time isn't on our side, and we're sitting in a ticking time bomb.
It's a known fact that a large majority of the world's baby boomers are not adequately primed for retirement, lack the financial resources to meet mounting healthcare and insurance obligations as they further age, and are more dependent on the state's hospitality than ever before. But who pays the ultimate price?
The prospect of $20 oil prices has been raised thanks to this one Black Swan. A Black Swan is also known to statisticians as tail risk, or events that are highly improbable but are of great significance. One can liken such an even to a large meteoroid making its way through the Earth's protective atmosphere and impacting land or sea; an extremely unlikely event but if actually true, mankind's existence would be threatened.
Low oil prices have been the bane of many oil producing and export nations, whose currencies and economies have taken incessant hits every cent crude continues to plunge. The ruthless combination of a huge supply overhang and waning global demand has led to a deadly concoction oil producers and exporters have no choice but to drink. What other choices would they have anyways?
Whatever we said on 5 November came true. For the first time in 9 years, the Fed hiked the Fed Funds target interest rate by 25bp to 0.25-0.5%, ending an eon of zero lower ground rates and marking the start of a new paradigm. A paradigm that is, much as most would hate to admit, unprecedented in terms of scale and bredth.
As we approached 16 December, markets had increasingly discounted a Fed liftoff, but there was still some element of uncertainty. That uncertainty now shifts to what the Fed will do in 2016. Will it continue to gradually hike rates? Will it reverse on its path of monetary tightening and start to ease? These are but a multitude of questions that everyone is asking, but no one can really answer.
Does dovish rhetoric from Europe's ECB, continued stimulus from China's PBoC, the reluctance of Japan's BoJ to step up QQE despite headwinds, New Zealand's RBNZ policy being put on hold signal a soon imminent Fed rate hike?
While correlation might not necessarily be causation, especially in the ubiquitously tangled web of central banking, we believe this development is too significant to turn a blind eye on. Ironically, market-based odds for a December Fed rate hike have never been higher.
Do central bankers know something about the Fed's near term actions which the general market doesn't? If anyone knows what the other will do, it's probably them.
We'll leave this up to you to decide. The proof is in the pudding, and this one's pretty dense. So take it for what it is, we're playing it cautious but not holding our breaths.