As the BOJ concludes its historical quantitative easing, we revisit a time when it just began, March 2015:

Bloomberg data shows that a new car costing 2.5mm Yen, in $ terms:

  • with USD/JPY at 83, less than a year ago, costs $30,120.
  • with USD/JPY at 96, the current rate, costs $26,042.

This $4,000 difference highlights how the Yen decline can strengthen Japan’s exports and economy, as relatively cheaper goods encourage foreign demand.  The third largest economy behind the US and China, Japan’s exports contribute 18% of their GDP.  This export-gambit will not only help Japan, but the global economy (See Japan’s Light-Switch to Growth).  The WSJ admits “Japan’s weakness has deprived the world economy of growth during the recessions and debt crises of the past decade.  If the Bank of Japan experiment works, Japan could once again become an engine of global prosperity, as well as a more effective economic counterbalance to China.” (3/21/13)

BOJ governor Haruhiko Kuroda & Prime Minister Shinzo Abe are lockstep in execution.  Kuroda’a will shift BOJ monetary policy more aggressively, likely buying longer (10 or 30 year) bonds during his first policy meeting in April.  Similarly Abe has already pledged Y10.3 trillion in fiscal support, as emergency government spending  while also negotiating to join US led pan-Pacific free-trade negotiations.

Failure is not an option, possibly destabilizing Japan’s juggernaut bond market (already the worst of all developed countries at 237% GDP) and $23 trillion financial system.  Losing control over debt payments could undermine confidence and spark a credit crisis.  Other risks include inflation through higher import costs increasing prices for commodities and consumer goods prior to an increase in wages and profits, hindering economic growth.

Will it work?  The Yen has weakened 18% while stocks have risen 40% since mid-November.  This gain in stocks has increased household assets to their highest level in 5 years, helping Japan’s consumer confidence index gain over 10% this year.

While the Yen currently rests at Y95 / $, analyst suggest it has to depreciate to to Y155 for the country to hit its 2% inflation target in 2 years (GS).  The lower Yen has already influenced prices, with energy and electricity costs up 4% and 19% respectively.  On the same note, some business leaders have already answered Shinzo Abe’s calls for increasing wages,  boosting bonuses by 3%.

Japan exports 15% of the world goods and services, from motor vehicles (21% of total exports); non-electrical machinery (also 21%); consumer electronics and semiconductors (18%); chemicals (12%); iron and steel products (6%) and scientific and optical equipment (3%).  (World Bank Data)

Nothing to Yuan about


China’s Yuan gained today to its highest level (6.3515) since its devaluation August 10.  The difference between domestic and offshore Yuan trading has evened after widening as much as 2% during the devaluation, while Wednesday’s foreign reserve showed a much smaller decline (-$43 billion to $3.51 trillion) in September, suggesting diminishing capital outflows.  Now only -2.2% against the dollar since that fateful August day, investors forecast stabilization as the central bank plans to issue its first yuan-denominated bonds in London in an effort to broaden the international use of its currency.  Among the Yuan’s supporters, Treasury Secretary Jack Lew said Tuesday that they US would support the inclusion of the Yuan into the IMF’s basket of global reserve currencies.

A Tumultuous Year Ahead

Wall Street’s S&P 500 Year-end Forecasts:

  • Federated Investors: 2350
  • RBC: 2325
  • Morgan Stanley: 2275
  • J.P Morgan: 2250
  • BTIG: 2200
  • Blackrock: 2160
  • Barclays: 2100
  • Goldman Sachs: 2100

Wall street firms polled by Birinyi Associates see the S&P 500 rising an average 8.2% this year as accelerating economic expansion and corporate earnings growth outweigh the detrimental effects from increasing rates. This comes after the S&P 500’s 11.4% gain and 53 record highs last year, extending the US bull market toward its 6th year anniversary this March.

Not one firm polled sees equities declining despite the Fed’s warnings of increasing volatility as they normalize rates. The Fed’s proclamation has already come true with VIX averaging 19.3 so far this year compared to last year’s average of 14.3. Despite higher volatility, stocks so far remain flat.

Studies show that stocks can continue to climb during the early stages of a tightening cycle (WSJ). Ben Carlson provides more detail in his Wealth & Common Sense blog, revealing that out of the 14 tightening cycles since 1950, in only 2 instances stocks lost value (bonds lost value half of these times). Furthermore in no instance was the rest of the globe embarking on massive QE while the US was normalizing rates, a situation that will offset any Fed effect (other than a strong dollar).

The dollar will continue to rally, fueled by the widening monetary divergence between the US and the rest of the world. Nevertheless any currency pressure on exports (13% of GDP) will be offset by low interest rates and oil prices. Depressed by an influx of foreign capital from the ECB ($68 billion/ month QE starting March) and BOJ ($60 billion/ month QE), lower interest rates will help US consumers (71% of GDP) in the form of lower borrowing rates, and corporation in the form of higher margins.

While the Fed has fixated on a June rate increase, international demand for higher yielding US assets will dampen the effect of the Fed’s rate hikes, holding interest rates low while boosting stock higher. TIC flow data (November: +$53.5 billion) already showed a record $6.112 trillion in Treasury bond held by foreign investors. Their insatiable demand will nearly create a bubble in US assets as long as their central banks keep printing money.

Equities are already pricey with the S&P 500 trading at 16.3 times forecasted earnings at the end of 2014 versus a historical average of 13.9 (WSJ & Factset). Similarly the index trades at 1.7x its expected sales this year, 31% higher than its 10-year average of 1.3. Nevertheless stocks will find momentum in earnings growth, forecasted at +6.3% for the full year which would be the best yearly performance since 2011 (WSJ).

Already pricey US assets temper Goldman Sachs PWM’s forecast to a 4.7% to 8.4% gain for the S&P 500 this year. Instead they recommend 2 foreign markets: Japan and Spain. Similarly Blackrock suggests cheaper Asian stocks like China and Japan (beware China’s margin levels).

Unfortunately strong economics correlates into stock performance worse than rainfall (Vanguard). While the US is a positive outlier economically, Barons reminds us of “the much heralded initial jobless claims numbers that hit a 14-year low last fall. That number also hit lows in June 1987, March 2000, and June 2007, which were all close to major market highs.” Beware for a precipitous decline in US stocks once the rest of the world stops printing money.

WSJ Monthly Survey of Economists

Faster job growth, consumer confidence (albeit volatile recently) and lower energy prices will boost US growth in the 3Q (+3.2%) and 4Q (+3%) this year.  Inflation adjusted consumer spending will grow 2.6% in the 2H this year, helped by lower energy prices (by 13bp in the 3Q and 21bp in the 4Q).

Oil prices are expected to close 2014 at $91.16, down $9 from June predictions. Inflation expectations are consequently lower, expecting annual CPI growth of 1.9% by year end.
Employment growth will average 214,000 over the next year, (227,000 current year average). Therefore unemployment will finishing the year at 5.8%, then finish 2015 at 5.4%.

The only headwind to growth lies internationally as Europe and Asia slow, while a stronger dollar curb US exports. That and some hesitation to higher interest rates… but higher rates only come when the economy is strong enough to support them.

THE TRADE (risk off) buy dollar, treasuries and sell Euro, Yen, commodities, small-caps and emerging markets.  Buy domestic large caps with little international exposure.  Dollar vs. Ruble looks perfect.

This just about sums it up.

An illuminating income and spending report last week:

August Personal Income & Spending: +0.3% & +0.5%. Both gauges rise as expected, given the strong August retail sales report (8/16/14 showing a +0.6% gain). Compared to last year, income (+4.1%) is outpacing spending (+4.4%), resulting in a little savings. Consumer prices were unchanged in August, leaving a very calm (+1.5%) annual gain that gives the Fed room to keep rates low. Core consumer prices gained (+0.1%) in August but also remained at a subdued (+1.5%) rate. Expansionary monetary policies in Europe and Japan will keep interest rates low, strengthen the dollar and keep inflation at bay.