Japan’s $1.2 trillion Government Pension Investment Fund will increase its allocation target for local shares to about 25 percent from 12 percent, the Nikkei newspaper reported without attribution. GPIF will also boost its holdings of foreign bonds and stocks to about a combined 30 percent from 23 percent, while reducing domestic debt to the 40 percent level from 60 percent, the Nikkei said Oct. 18

“Twenty-five percent is more than the market expected,” said Kenji Shiomura, a Tokyo-based senior strategist at Daiwa Securities Group Inc., Japan’s second-largest brokerage. “They probably can’t buy all the Japanese stocks they need to get to 25 percent by the time they announce it. However, it wouldn’t be a surprise if they’ve already started moving bit-by-bit.” 

 

The Dollar unwound much of its short-term overbought condition from early this month and found support last week in the region of the January highs. Some additional steadying in this area is a possibility but a sustained move below the 200-day MA, currently near ¥105 would be required to question medium-term Dollar dominance. 

 

The yen fell the most in a week and domestic stocks unwound some of their slide after Shiozaki, whose ministry overseas the nation’s $1.2 trillion Government Pension Investment Fund, said today the government will conduct some reforms within the existing law and there is no intention of postponing the process. The GPIF changes are accompanying Abenomics, a three- pronged policy of radical monetary easing, fiscal stimulus, and pro-growth policies.

The currency strengthened 0.3 percent yesterday, the most since Sept. 3, after a Yomiuri newspaper report cited Shiozaki as saying that he is in no hurry to submit a bill needed to review GPIF’s allocations.

“The yen’s reaction after Shiozaki’s remarks explains how closely the market is listening to him,” said Daisaku Ueno, the Tokyo-based chief currency strategist at Mitsubishi UFJ Morgan Stanley Securities Co. “It helps explain the enormous expectations there are around how the minister in charge of the world’s largest pension fund will revamp GPIF in a way that cater to Abenomics’ fight to exit deflation. Shiozaki is ‘Mr. Risk-on’.”

 

The three arrows of Prime Minister Abe’s program for Japanese economic revival are fiscal stimulus, monetary easing and structural reform. Of these the monetary stimulus has been both the easiest to achieve and the highest profile. The Yen has been among the weakest currencies in the world over the last two years and extended its decline this month to reassert the medium-term downtrend. 

With asset purchase tapering close to completion and the turning point in the Fed’s monetary policy cycle approaching, focus on the Fed’s monetary policy normalisation process is growing. On this front, the FOMC released a supplementary document that outlined its “policy normalisation principles and plans”.

The FOMC stipulated that the recent discussion on the topic of normalisation is part of its “prudent planning” and did not imply it “will necessarily begin soon”. According to the FOMC, many of the normalisation principles adopted in mid-2011 remain applicable. However, in light of changes to the System Open Market Account (SOMC) portfolio in recent years and other enhancements in the tools available to the FOMC, some adjustment to the previous guide may be necessary.

All but one member of the FOMC agreed on the following key elements of the approach intended to be taken when monetary policy normalisation was deemed appropriate:

(a) When less policy accommodation is warranted, the FOMC will raise the “target range” for the funds rate. During normalisation, the Fed intends to move the funds rate into the target range “primarily by adjusting the interest rate it pays on excess reserve balances” (IOER).

(b) The Fed also intends to use an overnight reverse repurchase agreement facility and other supplementary tools to help control the federal funds rate. In our view, this is designed to keep the effective fed funds rate from falling too far below the IOER rate.

(c) The size of the Fed’s balance sheet will be reduced in a “gradual and predictable” manner, primarily by ceasing to reinvest repayments of principal on securities. The FOMC expects to “cease or commence phasing out reinvestments” after it beings to raise the target range for the federal funds rate. Selling of Mortgage Back-Securities is not anticipated to be part of the normalisation process. But should limited sales be warranted in the longer run, such sales would be communicated in advance. 

A link to the full report is posted in the Subscriber's Area.

As we approach the end of QE tapering, it is logical to ask when the size of the Fed’s balance sheet is likely to contract. Since the rally on Wall Street has been fuelled in large part by liquidity, the answer is an important one. 

Rakuten Inc. rose the most in five months after it agreed to buy U.S. rebates website Ebates Inc. in Japan’s largest e-commerce deal, a move that will more than double the e-retailer’s transactions from overseas.

Rakuten will pay $1 billion in cash for all of Ebates, it said yesterday. San Francisco-based Ebates offers cash rebates to customers who buy products ranging from laptops to lipsticks from the website’s retail partners.

Rakuten’s billionaire Chairman Hiroshi Mikitani is betting the purchase will help the Tokyo-based company push its global e-commerce strategy. Rakuten has also been investing in technologies such as mobile applications and online video as it seeks to add to its online marketplace business.

“This deal doesn’t just mean we’ve started a cash-back website in the U.S., I think we can operate this model all over the world,” Mikitani told reporters at a briefing in Tokyo yesterday. The purchase will lift the proportion of Rakuten’s e- commerce transactions from outside Japan to 16 percent from about 6 percent now, he said.

Rakuten, which operates Japan’s biggest online mall, aims to raise the proportion to 50 percent around 2020, said Mikitani, Japan’s fourth-richest man with a net worth of about $6.9 billion according to the Bloomberg Billionaires Index.

 

Facebook’s $19 billion purchase of WhatsApp in January garnered a great deal of media attention not least because of the price tag. When Rakuten bought Viber, a very similar service, a week earlier for $900 million it passed off without much comment. It seemed to me at the time that the VIber purchase was the better buy if one looks beyond the short term hype. 

Domestic ownership of JGBs has increased to 91.6 percent at the end of March from 91.4 percent in December 2012, when Abe took office, according to BOJ data. By contrast, Japanese financial institutions and individuals were net sellers of domestic stocks in the year to March 31, while overseas buyers boosted holdings of equities on Japanese bourses to a record 30.8 percent, Tokyo Stock Exchange data show.

“Japan has increased its exposure to bonds and sold the equity to the foreigner,” in contrast to Kuroda’s prediction that local investors will shift from debt to riskier assets, according to Smith. He has been in Japan since 1987 and joined CLSA in August 2011 after working with Jardine Fleming Securities in the 1990’s and a four-year stint at hedge funds, according to biographical information provided by CLSA.

JGB yields continue to benefit from Japan’s quantitative easing as they unwind the surge that following the introduction of the policy amid continued central bank buying. If the pattern of QE in the USA and UK is any guide upward pressure on yields is unlikely unless the consistency of the policy is questioned. 

Changing the composition of the pension fund’s holdings to include more equities represents a potentially potent tailwind for the stock market. In looking at Japanese funds I went to the Funds section of the Chart Library, found in the main drop down menu, clicked on Funds by Geographic Focus and selected Japan. 

Abe needs to push through structural reforms to spur the world’s third-largest economy, Fitch Ratings said in a report last week, after gross domestic product shrank the most in three years last quarter. Japan isn’t alone in facing reduced inflation expectations as stagnant wages in countries from the U.S. to Germany and Australia threaten to slow economic growth.

“Japan’s economy has taken a severe knock which, inevitably, calls into question the credibility of the government’s reflationary program,” Nicholas Spiro, managing director at Spiro Sovereign Strategy in London, said in an e- mailed response to questions yesterday. “Abenomics is far from dead and buried but it’s increasingly on life support.”

GDP plunged an annualized 6.8 percent in the three-months through June, the sharpest contraction since the first quarter of 2011, the Cabinet Office said on Aug. 13. That clouds the government’s plan to raise sales tax next year to 10 percent after a three percentage-point increase in April to 8 percent.

Disapproval Rating
Three-quarters of people said they oppose a further levy, according to a Jiji survey conducted Aug. 7-10. The cabinet’s disapproval rating rose to 35.1 percent, the highest since Abe took office in December 2012.

“The ‘Abenomics’ fiscal and monetary stimulus policies have been sufficient to bring Japan out of deflation, but this is proving a double-edged sword as wages are not keeping up with prices,” Fitch, which has an A+ grade on Japanese sovereign debt with a negative outlook, said on Aug. 13. “Sustained real wage contraction would risk tipping Japan back into sluggish growth around or below potential.”

The cost of living in Japan grew at three times the pace of wage increases in June. Core consumer prices excluding fresh food rose 3.3 percent from a year earlier, while average overall monthly earnings gained 1 percent. When the effects of the consumption levy are excluded, inflation stood at 1.3 percent.

 

As the Japanese administration continues to support quantitative easing, the sales tax hike was necessary in order to ensure the credibility of government finances. JGB yields continue to steadily compress following the initial spike higher in early 2013. This highlights just how fine a line between fostering economic growth, promoting inflation and containing government borrowing costs the country is treading. 

Only 16 of the 100 global indices in the list have a P/E of less than 15. Russia, Argentina and Venezuela all feature but lack the improving standards pf governance we regard as an important ingredient for investment. 

“The data suggests there are some structural issues at play,” Daiwa SB’s Monji said. “Maybe the weak export numbers are because of Japan lacking competitiveness abroad. It’s negative for the market.”

Nikon sank 2.6 percent to 1,616 yen. JPMorgan reduced its rating on the stock to underweight from neutral, citing high costs and downside risks to existing businesses in the camera maker’s plans to increase its medical business sales.

Even after a 8.6 percent rebound from its May 21 low, the Topix is still the worst performer this year among 24 developed markets tracked by Bloomberg. The measure capped a world-beating rally last year as the central bank pressed ahead with record monetary easing.

The gauge traded at 1.2 times book value today, compared with 2.7 for the S&P 500 and 1.9 for the Stoxx Europe 600 Index yesterday.

Japan was one of last year’s early leaders but is today trading around the same level as when it hit a medium-term peak in April 2013. This ranging consolidation has resulted in a period of underperformance, not least against the USA and Europe and caused investors to question the fortitude of Mr. Abe’s administration in implementing his three-pronged reform agenda. 

The price action suggests this reasonably lengthy period of underperformance may be ending and that Japan is unlikely to finish the year as the worst performing developed country stock market. 

“If the Japanese market does move up, do you expect the financial sector to be a leader or a laggard?”

Thank you for this question which may be of interest to other subscribers. Generally speaking banks, as liquidity providers, tend to do well in the liquidity-fuelled environments that one associates with bull markets. They often lead, not least because they are sensitive to these liquidity flows. We look for banks to do at least as well as the wider market as a new bull trend evolves because they act as confirming signals that a new trend, which can persist beyond the short-term, is beginning. 

“The focus today was whether the gauge could recover losses from ex-dividends,” said Yoshihiro Okumura, a general manager at Chiba-Gin Asset Management Co. in Tokyo. “There are expectations that the market will rebound come the new fiscal year as the government enacts reforms and policies.”

The consistency of the Japanese stock market’s uptrend is likely to be influenced by the ability of the government to deliver on the next tranche of reforms. 
 

“Thank you for covering Japan today [Ed. Friday], a market that Fuller Treacy Money has been favourably disposed towards for a while now. I always read with interest your views on potential or existing major market moves. I have some feedback to share, which I hope is taken constructively and not as criticism. 

In your comment above, you state the following: "The underperformance of the banking sector is a cause for caution however." As a reader, I wonder what I'm supposed to do with that knowledge. Investors are faced daily with the choice to buy, sell, or do nothing. Japan is a market that FTM has encouraged investors to look at (and presumably invest in). With that in mind, assuming that some readers are long Japan, what is one supposed to *do* with today's market review? I found it difficult to interpret what you wrote today into something actionable: buy, sell, or do nothing.

 

Thank you for sharing your opinion and I also covered this issue in last night’s audio. You are correct that we have been favourably disposed towards the Japanese market since late 2012. This is because we believed that the Bank of Japan would follow through on its commitment to weaken the Yen and that the government of Shinzo Abe would deliver on the reforms necessary to promote growth. 

As you will also be aware we have long said “Governance is Everything”. These developments represented a significant improvement in the trajectory of Japanese governance. Investors were rewarded by a near doubling in the Nikkei-225 between late 2012 and May 2013, while the Yen fell by more than 35% over the same period.  

Japanese equities - There is losing face and then there is underperforming even the Russian stock market this year. The Nikkei 225 is down almost 13 per cent and overseas investors are walking away in shame. They sold $11bn of Japanese equities last week - the biggest five day sale on record - and since January have returned 13 per cent of everything they accumulated over the whole of last year. But while foreigners have lost patience waiting for Mr Abe’s third arrow of reforms has Ms Yellen just hit the bulls-eye? A more hawkish outlook for US interest rates has pushed up the dollar 1.5 cents against the euro and may well mark the beginning of strength versus the yen. If so - provided tighter US policy does not bring everything crashing down - a solid run from currency-sensitive Japanese equities would not be far behind. 

The correlation between the weakness of the Yen and renewed interest in Japanese equities was among the most rewarding trades in the first half of 2013. However the bank of Japan’s concurrent efforts to contain a run-up in JGB yields has contributed to a moderation in their fervour for a weaker currency. This also helps to explain why the Japanese government has chosen to go ahead with a VAT increase when investors would much prefer to see further stimulus measures introduced. 

Japanese shares rose, with the Nikkei 225 Stock Average capping its biggest yearly gain in four decades, as the yen retreated past 105 per dollar to its weakest in more than five years.

 Nikon Corp., a camera maker that gets about 85 percent of sales overseas, added 1.3 percent. Nippon Sheet Glass Co. jumped the most on the Nikkei 225 after Daiwa Securities Group Inc. rated the shares new outperform. Maruha Nichiro Holdings Inc. dropped 2.7 percent after a report it will recall frozen food such as pizza after pesticide was found in the products. Nippon Paper Industries Co. tumbled 5.9 percent on a report its operating profit probably dropped.

 The Nikkei 225 added 0.7 percent to 16,291.31 at the close of trading in Tokyo, closing the year 57 percent higher, the largest such increase since a 92 percent surge in 1972. The Topix index gained 1 percent to 1,302.29, with all but three of 33 industry groups rising. The yen weakened 0.2 percent to 105.34 per dollar, its lowest since Oct. 6, 2008.

FT Money has been very bullish of Japan’s stock market since we first heard of Shinzo Abe’s reflationary plans in December 2012.  The only additional proviso, often mentioned earlier this year, was to hedge short the yen for maximum performance, shown here as USD/JPY.  

 This item continues in the Subscriber’s Area.

Households face the prospect of sustained inflation for the first time in almost a generation, a dynamic that could hurt spending unless wages begin to rise. The focus is turning to salary negotiations early next year that may determine the success of Abe's bid to reflate the world's third-largest economy.

“The data reflects the clear effect of rising import prices, said Hideo Kumano, chief economist at Dai-ichi Life Research Institute in Tokyo. ”The tone is strengthening for Japan to emerge from deflation and that is helping to set conditions for wage increases.”

One of the greatest challenges in breaking Japan's deflationary cycle has been in changing consumer habits which became accustomed to delaying purchases in order to secure lower prices. Aggressively targeting the value of the Yen has boosted prices for imported goods, not least commodities and especially energy. The next ingredient will be wage growth and we are already seeing signs of movement on this front with Nomura committing to increasing what it pays employees.

Germany's DAX Index has risen for nine consecutive weeks and eleven out of the last thirteen weeks. It is also more overextended relative to its 200-day moving average than at any time since this bull market commenced with a weekly upside key reversal in March 2009. The next downward dynamic (see examples following previous overextensions to the upside) will indicate the onset of a corrective phase.

Asia is on the cusp of a full-blown arms race. The escalating clash between China and almost all its neighbours in the Pacific has reached a threshold. All other economic issues at this point are becoming secondary.

Beijing's implicit threat to shoot down any aircraft that fails to adhere to its new air control zone in the East China Sea is a watershed moment for the world. The issue cannot easily be finessed. Other countries either comply, or they don't comply. Somebody has to back down.

The gravity of the latest dispute should by now be obvious even to those who don't pay attention the Pacific Rim, the most dangerous geostrategic fault line in the world.

Japan's foreign minister, Fumio Kishida, accused China of "profoundly dangerous acts that unilaterally change the status quo".

The US defence secretary Chuck Hagel called it "a destabilising attempt to alter the status quo in the region" and warned that the US would defy the order. The Pentagon has since stated that US pilots will not switch on their transponders to comply, and will defend themselves if attacked. Think about this for a moment.

Mr Hagel asserted categorically that Washington will stand behind its alliance with Japan, the anchor of American security in Asia. "The United States reaffirms its long-standing policy that Article V of the US Japan Mutual Defense Treaty applies to the Senkaku Islands," he said.

Whether China fully believes this another matter, of course. The Senkaku islands offer a perfect opportunity for Beijing to test the resolve of the Obama Administration since it is far from clear to the war-weary American people why they should risk conflict in Asia over these uninhabited rocks near Taiwan, and since it also far from clear whether President Obama's Asian Pivot is much more than a rhetorical flourish.

Besides, Beijing has just watched the US throw its long-time ally Saudi Arabia under a bus over Iran. It has watched Moscow score an alleged victory over Washington in Syria. You and I may think it is an error to infer too much US weakness from these incidents, but that is irrelevant. Beijing seems to be drawing its own conclusions.

Even if the immediate crisis can be defused, we are clearly sliding into a new Cold War. While it is dangerous, it could have paradoxical and powerful side effects. Rearmament lifted the world economy out of slump in the late 1930s, working as a form of concerted Keynesian fiscal stimulus. It could do so again.

The world could certainly use a Keynesian stimulus, although most of us hoped that would be infrastructure redevelopment. However, China has already done that, although perhaps not to everyone's tastes.

I have been concerned for some time about what Ambrose Evans-Pritchard discusses in this excellent article. China is definitely the aggressor in the East China Sea. Its World War II resentment of Japan, while understandable, can also be politically expedient. Moreover, China will not welcome the economic revival and rearmament of its old enemy. China is also testing President Obama. Additionally, due to its disastrous one child policy, China has a growing social issue with over 30 million excess males, who may be regarded as an expendable asset.

We should keep an eye on this situation because if it ever did go horribly wrong, the world's three biggest economies would be involved.

Probably the biggest of those fish is that giant part of the world economy known as Asia. The chart below shows the anticipated growth in numbers of the middle class throughout the world over the next two decades. The solid green circle is the current middle class population (or as at 2009 to be precise); the wider blue-fringed circle represents the forecast size of this population in 20 years' time. The OECD definition of middle class is those households with daily per capita expenditures of between $10 and $100 in purchasing power parity terms.

Note that in the US and Europe, the size of the middle class is barely expected to change over the next two decades. Central and South America, and the Middle East and North Africa, are forecast to grow a little. But one area stands out: the emerging middle class in Asia is forecast to explode, from roughly 500 million to some 3 billion people.

In equity investing, the combination of a compelling secular growth story and compellingly attractive valuations is a very rare thing, the sort of investment opportunity that one might only see once or twice in a generation, if that. But it exists, here in Asia, today. Once again, however, we have to abandon conventional financial thinking in order to exploit it.

This is a very good issue of Tim Prices' letter and I commend it to you.

India's Sensex Index (weekly & daily) falls back as the rupee (weekly & daily) weakens again, risking higher inflation and interest rates. Historic resistance above 21000 has turned back the stock market rally and underlying trading will be tested unless the Reserve Bank of India Governor Raghuram Rajan can once again turn back the rupee's slide, shown inversely above against the US dollar.

“With USDJPY crossing 100 today is now a good time to sell the Yen and buy the Nikkei, or am I too late? Would be interested in your thoughts.”

Thank you for this topical question which also crossed my mind as I was conducting my morning click through of global markets. The Bank of Japan’s commitment to shocking the economy out of deflation remains in place and is a major influence on the Yen, Japan’s significant export market as well as domestic inflationary expectations. .