23/03/2011 Author: Gwyn Roberts

JAPAN: What next?

With markets dwarfed by the scale of Japan’s human tragedy, the hedge fund response to the crisis has been understandably sclerotic. A slither have been able to take advantage of a confused Nikkei, more have maintained an already bearish stance on Japanese bonds and the long-term strength of the Yen. While all – at least those with some element of Japanese exposure – are concerned about nervous investors, running from a market whose next gyration, particularly given the grave condition of the Fukushima Daiichi power station, remains impossible to predict. HFMWeek spoke to managers, service providers and investment experts as they defined the possible outcomes of an impossible situation.

GLOBAL IMPACT
Japan’s nuclear crisis could eventually cut its ability to generate power by 30%, meaning the large-scale importation of fossil fuels and the inflation of world energy prices, with a knock-on effect on global GDP. In the midst of its own sovereign debt crisis, European stocks were buoyed by the Japanese buying ¤60bn ($85bn) of European bail-out bonds – a deal presumably now in the balance as funds are dedicated to a domestic recovery, “triggering problems in the Eurozone,” said one manager. Stock pickers could benefit as the volatility leads to a cooling of the uniform rally in global equities. Markets that received incomes from Japanese investors, like the luxury goods market, could be hard hit, as demand tails off. Conversely, as some countries take a bearish stance on nuclear energy, alternative energy stocks will receive a lift.

JAPAN'S ECONOMIC OUTLOOK
Tohoku, the region hit by the earthquake and tsunami, accounts for a relatively small shard of Japan’s total economy. As such, the managers HFMWeek spoke to expected a small national GDP drop of between 1-2% this year, as frozen supply chains and battered facilities hamper production. Yet most also predicted a relatively fast recovery as state intervention and repatriated cash begin to mitigate a short-term blip by the middle of 2012. “We expect growth to be boosted by rebuilding activity, partly from the private sector and partly from expected government stimulus”, said Nick Linnane, portfolio manager at Cube Global Opportunities Fund, part of Cube Capital. However, in the longer-term the country’s growth prospects remain limited by an ageing population and high levels of debt.

FX MARKETS
With many already bearish on the yen, managers were sticking with this sentiment even in the midst of a rally, brought on by the repatriation of cash. Macro players could well increase short positions in the currency as they anticipate long-term drops and devaluation via more government intervention. “We’ve been bearish on the yen for some time”, one manager told HFMWeek, “the current strength is irrelevant.” The intervention of the G7 on Friday appeared to stabilise a climbing currency, hitting post-World War II highs against the dollar on Thursday, while managers are betting on further falls.

BOND MARKETS
Japanese debt has long attracted the bears, growling at the country’s historically unsustainable debt levels and its growing reliance on China. However, it is the terrible effects of nature, not nurture, that has proved them right – as spreads widen on companies affected by the disaster and on Japanese Government Bonds (JGB), whose price has lifted. The cost of insuring JGBs for five years also rose to a high of 120bps on Tuesday, before falling to 107bps on Friday. Credit default swaps on domestic energy and travel companies have similarly sky-rocketed, with market data showing a five-year credit default swaps (CDS) on Nuclear plant operator TEPCO hitting 400bps on Tuesday, before dropping to 290bps at the end of the week.   

THE NIKKEI
Japanese shares were considered cheap before the crisis, and are even cheaper now after enduring a period of over-selling. However, the repatriation of Japanese money and the intervention of the G7, easing export fears, could quickly push the market higher, offering a narrow window for managers. The increased dispersion of stock-price movements within particular segments has also created opportunities for those who have a sufficient existing understanding of local markets. “Don’t make the mistake in thinking there is one Japan, there are many Japans – some stocks will benefit and overall I remain quite bullish on prospects here,” said Frank Packard, Tokyo-based president of Triple A Partners Japan. However, a majority of the managers HFMWeek spoke to are still minimising exposure to local markets, rather than seeking obvious buying opportunities.