As market panic rises, I like to bottom-fish.
Of course, timing is important but I don’t stake the success of my portfolio on the correct interpretation of technicals, flows and volatile indicators. As I discussed in Part II of my book, I trade when I see a clear extreme value and trying to time may only muddy up my risk profile.
Due to a large bond futures position, my portfolio has been trading with a strong risk-negative flavor for over a year, while in 2014 the long dollar and long equities provided a better balance. The fact that I am beginning to fish for cheap risk assets doesn’t signify a bottom is here or even close. Given my view that the China unwind is only beginning, I am inclined to expect that global financial markets will get even more dicey. But as I have said, I don’t like to over-invest in such directional bias. Risk may bounce and I don’t want to be forced to chase.
In Part III of my book, I discuss my principals of portfolio construction. In abbreviated form, rather than have just trade A pointing in the direction of my view, I prefer to have superior trades A and B pointing in the opposite directions.
My intention is not just to make a lot on one trade versus lose a little on the other. Rather, I plan to make money on one trade NOW and make money on the other trade LATER. So when I look for a risk asset I want to find something that may go further underwater first but is likely to emerge profitable. Indeed, not ALL risk assets rise from the ashes and investors need to show deference to secular changes. Consider Citibank.
In the 1990’s, the firm was a great buy and every dip was an opportunity. However, in the 2000’s it DID get wiped out – diluted beyond reasonable hope of recovery.
Well, that’s an individual stock market example. The broader market in the USA tends come back with the vengeance after every few years of meandering. Even the Great Depression which followed the 1929 peak took “only” 25 years to be redeemed.
But is this pattern true of global stock markets? Definitely not to the same extent. Nikkei is now over 35 years from the peak and nowhere close to making new highs.
Yet when I look in the mirror like Larry the Liquidator, played by Danny Devito in “Other People’s Money”, and ask “Who is the fairest of them all?” I am beginning to suspect the answer will be Japan.
The Nikkei may be positioned for a multi-year run to the new highs. Before I go further, I reiterate that China unraveling is a big risk to Japan but this is exactly the risk I am NOT worried about because I ammlong USTs and short RMB. I only need to be concerned with scenarios where China does ‘OK’ and the world doesn’t fall apart.
Three reasons I particularly like Nikkei and note that none of them are the introduction of NIRP.
I. Core inflation is rising and this is good for nominal profits. I often scoff at “core” inflation in theUSA positing that energy is as important as any other CPI input. But Japan is different because unlike US, it is a pure importer of oil. And steel.
Japan CPI Nationwide Ex Food & Energy YoY% (VAT spike notwithstanding):
Iron Ore Prices, USD/Metric tonne [China Import Iron Ore Fine 62% FE Spot (CFR Tianjin Port) ]
A simple prospective of the wealth of the nation makes me bullish as they buy their inputs more cheaply and, due to the weak currency, sell their products expensively.
The recent upturn in the JPY shouldn’t cause a big problem given that the BOJ policy is likely to contain the Yen rally from extending. But even if the Yen strengthens further, a strong and stable domestic currency is a good thing, unless it’s TOO STRONG which is unlikely.
II. Japanese demographics may have a silver lining. An interesting point brought to me originally by @WorthWray is that the country’s aging population and declining labor force may prove to be a blessing in disguise. Shortage of labor pushes Japan to build on its strength: robotics. Japan is less likely to experience a backlash from job elimination caused by automation.
III. Regional instability. The last somewhat grim point is mine. I see a high likelihood of economic destabilization in China leading to political destabilization. As stated above this is probably not good for the Nikkei in the short run, but there is potentially a significant, long-term benefit. If crumbling China becomes externally (or possibly internally) aggressive, it will destabilize the entire region. That means a carte blanche for Japan to RE-MILITARIZE. And military build-up is usually very good for the stock market.
Good luck catching falling knives and keeping Band-Aids handy!
Image: “Japan” by Moyan Brenn
Chart source: Bloomberg
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