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valuevulture999 (67.98)

Yen of an opportunity!

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July 12, 2010 – Comments (4) | RELATED TICKERS: EWJ , FXY

reprint from my blog : http://valuevulture.wordpress.com/ 

 

When you think of Japan we get images of  Toyotas, Pokemon and Sony Playstations. What most people don’t realize is that Japanese stocks are probably the most unloved and undervalued of all investments currently out there! If you had invested in Japanese stocks at its market top and held to know, you would have lots over 75% of your investment. It is what Warren Buffet would call “Permanent destroyer of Capital”.  As a contrarian and value investor I always look for opportunity wherever they may be especially those that are generally ignored by everyone. In this case Even the Japanese don’t even buy their own stocks. Earlier in the year, a famous contrarian money manager Marc Faber during a Barron’s round table discussion highlighted Japan as the trade of the decade!  Any discussion of Japan cannot occur without discussing the Yen as well. Let’s begin……

The Background:

The fiscal policy of the Japanese Economy has always been geared to favor exports over domestic consumption since the end of WW2 to help rebuild a shattered economy under a 1 party system known as the LDP. By the end of the 1980′s, everyone was afraid that they would buy up the world. Like all credit bubbles, this burst with unbelievable ferocity.  For the next 25 years their economy seesawed between deflation sub par growth. To combat this, successive governments tried to stimulate themselves out of a depressionary spiral with road projects to nowhere. Just think Obama stimulus on steroids. Whatever stimulus scheme they would come up with it didn’t resolve the problem of zombie banks and an inefficient economy. As you should know by now, politicians are the worst allocators of capital. Can you say “Congressional Earmarks”? From the crash of 1990 to the year 2001 it was just one never ending horror show. Something interesting happened in 2001 that started to change the environment. They elected Koizumi as their prime minister who served in 2001-2006. He was their version of Bill Clinton. As Japanese politicians go, he was a real reformer. He pushed to fix the Zombie banks, privatize the postal savings system and the reform of the LDP itself.

Economic Stats:

Since 2002 Japan has had GDP growth of 2.2% on avg per year. There is low inflation with CPI growing at .8%/year. M1 & M2 money supply growing at 5.6% and .3% respectively. The legendary household savings rate fell from the high figure of 17% to 3.3% due to a rapidly aging population and low replacement birth rate of .9%. The high savings rate had help to internally fund the deficit spending  to a total debt of 380% of GDp. This is worse than Greece. Whenever Japan gets into trouble it always exports itself out of trouble. People talk about Chinese exports but the Japanese are just as relevent today as it were in the 80′s.

Where are we now:

Ever since the end of the Koizumi government , the japanese government has seen 5 different prime ministers in the span of 4 years. The government has seen growth through exports but it is still fragile. However, as a result of previous restructuring reforms, something is stirring under the surface. We are beginning to see MA activity focused primarily on the smaller to midcap companies with the Chinese as the biggest buyers.  It will be a matter of time until you see a large acquisition or merger. the Japanese are not standing still themselves. They are beginning to do alot of cross border deals to strengthen themselves and go further up the value chain to better compete against the chinese.  Japanese stocks are only;y up 5% for the year compared to 50% or more in most other markets. The most valuable part of  most corporate balance sheets are their high cash positions due to stingy dividend payments and intellectual property that is second to none. In 2010, so far there have been 18 deals which are more than the total of 2009. Things are beginning to resemble the US before the M&A boom of the 1980′s.

The Yen has also showed some real strength lately to rise to 87.50 yen to the dollar. Anything below 90 yen to the USD is considered very painful for their exports which affects their general economy. Part of the yen strength is due to safe haven status from the Euro crisis and an improving economy. The BOJ is always hostile to a strong yen and will make market actions to devalue to currency to maintain the competitiveness of Japanese exports. What is good for Toyota is good for Japan! Another factor for yen weakness is the stunning loss of the DPJ majority party this weekend which should complicate debt reduction and other reform measures. Bad for the yen but great for the stocks.

How to profit:

This is a 2 pronged investment. First capitalize on yen weakness by buying the FXY put contracts for Jan 2011 105 strikes. I bought 50 contracts earlier in the week at $1.42. If this currency ETF falls to $105 from $111(currently) I will have an estimated profit of $10,931. If I’m wrong and goes up even more in value I only lose my $5k. If it drops below $105 profits become unlimited.

Secondly I purchase some EWJ ETF options to capitalize on the rising Japanese stock market. This gets complicated because I decided to take positions to profit whether the market collapses or rises. I will profit in either scenario. In the first leg of the trip I bought 100 contracts of the 2012 Jan $11 call strikes at $.70 (for upside) and 100 contracts  of the jan 2012 $7 put strikes @ $.44. So if the etf should rise above  $11 upside is unlimited. If it should fall to $5 I will make  $11,735.

Happy hunting!

Albert louie

4 Comments – Post Your Own

#1) On July 12, 2010 at 10:53 AM, Superdrol (56.57) wrote:

i like the puts on the FXY.  I am also short FXY myself.  I'm not sure about the EWJ though as a long.  Japan is 96% or so interally funded with their own debt.  This allows them to keep artifically low interest rates and cost of capital.  At the same time because of the way that their debt is structured, their aging population and high savings that are integrated into these bonds, I am very leery of Japan overall.  If there is a continued withdrawl of savings out of these bonds, Japan may have to finance out on the open market internationally and will not be able to sustain interest payments b/c of their cost of capital.

I think Japan has been fortunate for such a long period of time to be able to draw up a massive deficit with absymally low interest rates, but that will not continue forever.

I do not wish any ill-will, but Japan is spiraling out of control and also their political structure seems to be the biggest impeding factor.

 

This of course assumes that there is not another type of global depression which will affect them.

 

Japan is scary to me, and as a developed nation that are in very poor financial condition.

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#2) On July 12, 2010 at 10:55 AM, Superdrol (56.57) wrote:

I think the EWJ calls long is a good hedge you have set up, but Japan is a scary beast to be honest.

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#3) On July 14, 2010 at 3:36 PM, valuevulture999 (67.98) wrote:

The most interesting thing about Japanese stocks are that they either become predators or bait for someone else. this is the most interesting question of all. I am very bearish of the yen but a weak currency helps the stocks of an economy based on exports. Japan is comming to a fulcrum point where they either adopt policies that increase growth or wallow in stagnation. in today's WSJ, it looks like the political forces are putting the fires under the BOJ to increase growth.

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#4) On July 14, 2010 at 4:38 PM, Superdrol (56.57) wrote:

Did you read the piece of Kyle Bass ?  He funded his mortagage in Yen as he is so convinced they will either default or devalue, lol.  I do agree though.  Their cost of capital (due to internal funding) is extremely low (1.3%) and at some point if it increases that is probably what will do them in.

 

Their debt is beyond repair, IMO.  It will need to be re-structred at some point.

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