Hedge fund manager, Chris Rigg, manager of the Audley Japan Opportunities Fund and a 30 year veteran of the Japanese markets, has issued a stark message about investment in Japanese bonds…
The level of debt Japan is running, which by some measures is far worse than in Greece, is unsustainable. With net debt at 140% even if Japan were to run a budget where revenue and expenditure were balanced before interest costs, the economy would have to grow by 1.8% in nominal terms just to stabilise the debt/GDP ratio. The reality is that the Japanese government spends twice as much as tax revenue and debt servicing costs consume half of tax revenue.
Japan enjoys some of the lowest borrowing rates in the world, principally because of its current account surplus but this is now shrinking fast with Japan running its first seasonally adjusted deficit since 1981.
With a general election looming on 16th December and all polls predicting defeat for Yoshihiko’s Noda’s Democratic Party of Japan, we are looking for a major correction in bonds, currently near historic highs, whilst equities should increase, as the new government undertakes moves to eradicate deflation before the imposition of a consumption tax in April 2014.
We think the best way for Japan to exit deflation would be if the yen were to weaken as this would help the economy, increase consumer prices and cause the stock market to rise. The current policy of the central bank buying more government debt would have the effect of causing a bubble in bond prices and would do little to stimulate the economy or raise consumer prices. With the financial system much more exposed to a fall in JGB prices it is likely that a new BOJ Governor, who will arrive in April of next year, will pursue a policy of weakening the yen by purchasing foreign bonds. Such a change in policy will mark a major change and cause the long underperformance of Japanese equities relative to Japanese bonds to end.
We believes that Japanese bonds are grossly overvalued, trading at levels they have only reached twice before in 1998 and 2003 whilst Japanese equities are trading at valuation levels they last reached in the 1970’s. A change in policy will cause these valuation extremes to close.
