PMR Special Edition: Japan
Policy Normalization May Not Be Chill
No PMR Passport or Walk in the Pines this week. Instead we have a treat for you with an Emerald (our monthly deep dive letter) we wrote on Japan four months ago. With the news out of Japan last week (another step toward normalization) we thought it was important to share this piece. We will be back to normal next week.
The point of the piece was to take a hard look at worst case risks (so a bit hyperbolic on purpose) surrounding Japan inflation and policy normalization. Since we took another step in that direction with the YCC “tweak” it made sense to share this more broadly. Back in March, I was more convinced of imminent summer weakness in the US economy which now looks dumb which would change some of the commentary in this Emerald. We already see inflation proving more sticky than myself and the BOJ thought back in April. That means the wildcard scenario one quarter later is firming which means we should all be thinking that much more about the risks associated with policy normalization in Japan. If energy prices rip and Japan normalizes in the same six months - I cannot overstate the potential significance for global macro. Worth mentioning that oil ripping increases the chances of policy normalization in Japan in the sense that it keeps inflation high and pressure on the Yen.
This Japan Emerald combined with the May 13th Cascade (now unlocked) make it clear that I really like Japanese equities and I still do (more now). I have been wrong to be more in non FX hedged for sure, but this normalization starting may help the Yen push unhedged equities higher from here.
Japan has just started to do large buybacks, use stock based comp in size, etc. so one could argue their stocks have just started their ascent. We had 30 years of sleepy businesses hoarding cash and worrying about deflation and malaise. Now they have inflation and take seriously their equity values. They are putting their balance sheet to work to more efficiently allocate capital. Remember, US companies give back 80% of profits to shareholders - 30% more than in Japan. That is changing. Shareholder yield at a 13PE with strong growth and inflation trends and a policy rate that is wildly easy. So yes - I love Japanese investments but remember that the main point of this letter is the risk involved surrounding potential capital moving from major DM economies back to Japan. Take that part to heart because even if it is a low probability risk - it is such a big risk that it deserves your careful thought. Also investing is Japan has gotten popular lately which means it probably has a washout coming to separate chart chasers from those buying because the fundamentals have changed.