February 9, 2009 Market Vane Indicator Market Technicals Market Trading Volume Yen-Dollar Interest Rates Best Sector MTD Worst Sector MTD Economic Momentum
Closing Values
Direction Bear Market
Indicator Topix
Week Close 790.84
Prev. Week 773.55
Weak
NK225
8,076.62
7,745.25
Distressed Strong
TSE 2
1,872.90
1,894.47
Weak
JASDAQ
42.64
44.80
Shipping
JGB Yield
1.335%
1.230%
Foods
Yen-Dollar
92.06
88.85
Fast Deteriorating
EAFE ETF
40.70
32.25
Sources: Tokyo Stock Exchange, Nikkei Financial, TheFinancials.com
China: Still the Hope of the Industrialized World shift to domestic demand sufficient enough to offset a dearth of exports.
No sooner had the ink had dried on our bearish outlook for China (i.e., a potential negative GDP surprise) than news began filtering out that China’s PMI was bottoming, demand was returning for iron ore from Australia and of significant loan growth—in other words, signs that China’s $585 billion stimulus package was starting to kick in.
While the risk of another downleg in equity markets remains, the China news last week offered a ray of hope amidst a steady dirge of dreary economic and corporate news. Hope of an early recovery in China already triggered a nice pop in the volatile Baltic Dry shipping index (BDI) and a rally in the China ETF (FXI), sending traders in Japan, Australia and Asia scurrying for BDI/China proxies, such as iron ore producer BHP Billiton, shipper Kawasaki Kisen, trading company Sumitomo Corp. as well as the SEA ETF and the S&P Materials SPDR.
The CLSA and Nomura surveys of Chinese manufacturers offer encouragement that producers are getting inventories under control, while Australian iron ore exporters say China demand is returning. On the other hand, the Xinhua Finance/MNI China Business Sentiment Survey indicates that new orders have dropped sharply and prices have plunged to the point where deflation could become China’s battle as well. The gloom in this survey was reflected in other key indicators such as new orders and production. Plunging exports from Japan, South Korea and Taiwan in January also indicate continued weakness in import demand.
While the prognosis for Japan’s economy in 2009 remains bleak especially through the first half to September, stocks of Japanese trading companies, shippers and construction equipment companies are being positioned for a tradeable rally. We believe some money can be put to work on such China plays for at least a shortterm break-out to the upside. If the yen happens to weaken further in the interim, the budding bear market rally will be all that more powerful.
Ironically, the industrialized world is hoping that enough of the old centrallycontrolled China (as opposed to the modern capitalist China) is left for a major
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TJI MARKET LETTER 02.09.09
Upside Target for Gold is $1,000, But Move is More Questionable After That
Our Current Strategy… z
Continue to maintain high cash positions as the risk of another significant downleg in stock prices remains. Trade stocks defensively, buying on major sell-offs that push stock prices to oversold territory versus moving averages, but sell quickly to realize modest gains (+/20%?).
z
Consider backing off gold positions once the $1,000 milestone is reached, depending on the movement in Treasury bond yields and the USD index.
z
Something has to give on the USD index. Either concern about massive Treasury issues is overblown, or the disconnect between the back-up in Treasury yields and strength in the USD is about to be corrected. We would largely avoid both.
z
z
As investors are becoming increasingly concerned about a glut of US treasuries issued to fund economic stimulus and a new bank bailout package, there has been an equal warming to gold. Reflecting what is rapidly becoming the market concensus, Goldman Sachs has raised their short-term (3 month) price target on gold to $1,000/ounce, while their 12-month target is $825/ounce, implying they don’t exactly expect a blowout rally in gold. UBS has a similar target. Whichever sovereign was selling in the high $800/ounce range appears to have either slowed their sales, or this selling has been overcome by renewed investment demand for gold as a haven against the devaluation of fiat currencies.
The Obama Administration is encountering more resistance than anticipated to its economic stimulus plan as well as its long-expected bank rescue plan, delaying implementation and the time delay it will take for these programs to gain some traction. There remains both the potential for renewed disappointment (meaning a negative market reaction) and a pop in the bank stocks as traders cover their short positions.
The “Street” Has Warmed to Gold
Source: BigCharts.com
Carefully monitor signs that China’s stimulus package is gaining traction. Any further evidence of a bottoming here will provide trading opportunities in Japanese shippers, trading companies and construction equipment makers. A coincidental sell-off in the Yen would only make such a rally more powerful.
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The rise in price is separate and distinct from demand for physical gold (especially jewelry, which accounts for some 70% of total demand), which had been declining to near the lowest point in the past decade.
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TJI MARKET LETTER 02.09.09
that funds are again flowing between banks, this “distressed” demand for USD should be abating. On the other hand, a shrinkage in the US balance of payments deficit will reduce the supply of USD (a major part of the global money supply), ensuring that the supply-demand balance for USD remains fairly tight.
On the investment/speculation side, the long-short ratio of non-commercial trader positions has risen from 2.99 on October 28 to 6.75 as long positions have increased 41% from lows in Q4 calendar 2008, while short positions have declined by 53%. The number of open contracts at 347 thousand is significantly below the record hit a year ago at almost 600,000 contracts, meaning there are potentially lots more speculators who could be drawn in if gold prices continue to rise. In terms of cumulative trading volume in the GDL ETF, there appears to be an overhand of potential supply between $85 and $90 that could impede the short-term upside. Once through this potential resistance, gold could spurt past the previous high of $1,033.90/ounce (continuous futures contract) set last March.
USD strength however is related to the movement in US Treasury yields. Given a buyer’s strike in Treasuries, the USD index could very well be swept away as well, causing a renewed rush into gold. Is USD Forming a Double Top Or Is There More Potential Upside?
The extent of the upside in gold will depend on; 1) How investors react (and bond yields move) to the heavy calendar of US Treasury auctions going forward. Treasury yields, particularly on the shortermaturities such as the 5-year treasuries.
Source: StockCharts.com
3) Gold’s relationship with crude oil. The following gold-to-oil ratio chart from FT Alphaville shows that the “long gold, short crude” trade is getting very crowded. In other words, either a) gold will decline versus oil, b) gold will consolidate while oil rallies, or oil will simply begin outperforming oil.
Investors Are Increasingly Leery of Heavy US Treasury Issues, Causing Treasury Yields to Back Up
Crude is Looking Oversold Versus Gold Source: FXStreet.com
2) Whether or not the current rally in the USD index continues. The USD first rallied on a surge in demand for USD by financial institutions scrambling to ensure liquidity. With TED and other spreads indicating
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Source: FT Alphaville
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TJI MARKET LETTER 02.09.09
However, both China PMI measures are still well below 50, indicating continued manufacturing contraction, and the Xinhua Finance/MNI China Business Sentiment Survey indicates that new orders have dropped sharply and prices have plunged to the point where deflation may become the Chinese leadership's next battle. The headline overall sentiment index hit its third successive record low at 35.20 in December, down from 39.87 in November, and that gloom was reflected in other key indicators such as new orders and production.
Assuming a heavy calendar of US and other sovereign issues, ostensibly because of the ongoing requirement for heavy economic stimulus, the upside in oil will be stunted by a dearth in demand, while there will remain a strong undercurrent of save haven demand that would normally go into Treasuries spilling over into gold. Given a surprisingly early recovery in the US and global economies, gold would tank along with Treasuries, sending investors scrambling to build positions in crude oil. However, we place a lower probability on this scenario for the foreseeable future.
Xinhua points out that the most alarming signal in the latest monthly survey was seen in the indexes for prices. The index for input prices, which was in the 80s as recently as August as the government fought inflation on a number of fronts, hit an all-time low of 26.36, a record low for the third straight month. The index was at 31.89 last month. The index for prices received rose slightly but remained near the record low set last month. The price index was 36.82 in December, up from 35.56 last month. The survey indicates companies appear to expect prices to continue falling.
False Hopes For An Early China Recovery? Signs that Chinese manufacturing was beginning to bottom has had traders the last few days buying everything from the BDI (Baltic Dry Index) to Asian shippers. A CLSA survey of Chinese manufacturers showed a slight improvement, and the release of official manufacturing activity bolstered hope that a slow recovery might be taking place. A survey of 500 Chinese firms in 60 cities from December to early January showed that 60% had cut inventories to one or two months' of sales, down from three to four months-suggesting the next step may be a restocking of inventories.
2009 Implosion of Total Exports/World Trade in SH2008, FH2009 Could Look Like 2001 10 8 6
Australian iron ore exporter executives fanned such speculation, saying that the iron ore spot market is again on the move, the bottom of the slowdown has been reached, and prices are starting to come back. This plus evidence improved shipping activity in Capsizes, the largest vessels, as Chinese steel makers buy more iron ore from Australia and Brazil, caused a nice pop in the BDI.
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4 2 0 -2 1950-60 1960-70 1970-80 1980-90 1990-00 2000-07
2001
2002
Volume of total ex ports
2003
2004
2005
2006
2007
GDP
The evidence of movement in shipping may merely be a thawing of essentially frozen trade finance during the height of the banking crisis in Q4 2008.
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TJI MARKET LETTER 02.09.09
fiscal year ending March 2009 (972 companies) shows that a 6.2% YoY decline in sales for the year will result in a 62.3% YoY plunge in ordinary profits。
As pointed out last week, China’s economy has a positive correlation with the OECD leading indicators as well as electric power production in the country, both of which are currently strongly negative. Thus it is already abundantly
In particular, Q4 (January~March 2009) ordinary profits will be JPY2.36 trillion in deficit. There was thus a very good reason that the Nikkei 225 plunged first late last year and bottomed on October 27—i.e., corporate profits were imploding!
clear that world trade has braked sharply, and the real question for China is how much of this can be made up with by stimulating domestic growth. Foreign Investor Sentiment on Japan is Now Almost Universally Negative
Total Corporate Ordinary Profits Were JPY2.3 Trillion in Deficit in Q4 FY08
Foreign investors appear to have essentially given up on Japan, seeing the economy as being one of the weakest among the OECD in 2009, and having become exasperated by the “Keystone Cop” antics of the Aso Administration. Source: Nikkei
As a result, they continue to reduce their positions in Japanese stocks, with net selling over the past year equal to about 15% of net purchases from 2005 to 2007.
Manufacturing, especially electronics and automobiles, has been particularly hard hit. The whole manufacturing sector is now expected to report a JPY1.1 trillion net deficit in FY08, for the first time in history, as companies scramle to slash production and drastically restructure their businesses.
In January, they sold another JPY830 billion of Japanese stock, and were also selling the futures. Brokers also continued to reduce their prop positions in Japanese shares. Since foreign investors had accounted for up to 70% of the value of Japanese shares traded, their selling has had a strongly negative impact on Japanese shares.
While investors were shocked by the largest-ever decline in Japan’s exports of 35% YoY in December, the flash report
for January exports indicates January exports dropped by half! In other words,
Thus foreign sentiment on Japan is definitely swinging toward the excessive side of the pendulum swings in foreign investor sentiment regarding Japan, which inevitably are either too bullish or too bearish. Corporate Imploding
Profits
are
this alarming decline is by no means over, and indeed has been accelerating coming into the New Year. Japan’s composite index of coincidental indicators in December fell 2.6 points to 92.3 for the fifth consecutive month, and the degree of decline was the third largest, following the readings last August and November, clearly indicating a general collapse of economic activity.
Literally
The Nikkei’s latest compilation of consolidated corporate profits for the Subscribe or renew at www.japaninvestor.com
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TJI MARKET LETTER 02.09.09
This could be enough for a decent rally in stock prices beginning sometime after
While Japan’s economy officially went into recession last November, the speed of the deterioration is unprecedented. Moreover, the leading coincidental indicator’ s three month moving average fell 3.23 month-tomonth for the 18th consecutive month.
investors get a good look at how bad earnings will be in the first half of the year. Consequently, we believe that Japanese stock prices are at the most risk of a renewed sell-off in the first half of 2009.
As we pointed out last week, the manufacturing inventory ratio has gone ballistic from November of last year, had surged to 127 as of December, and probably continued rising in January, judging from the implosion in exports.
We tend to agree with the conjecture that China will probably one of the first countries to pull out of the global recession/depression, even if growth slows more than current consensus estimates. If this is the case, investors need to be positioning their Japanese stock exposure to capitalize on this recovery. Consequently, in addition to owning the FTSE/Xinhua China 25 ETF, we would also hold the following Japanese China plays.
Consequently, we see production adjustments continuing at least until midyear, and continued massive deterioration in corporate profits through the first half (to September) of FY09.
It is these sort of numbers that have an increasing number of Japan observers stating that Japan has already fallen into a depression.
We have already seen a tentative testing of the waters of this investment scenario over the past couple of days, while the move would get a noticeable boost should the yen begin trading back toward JPY100/USD.
But The Swing of the Pendulum To Excessive Bearishness on Japan Could Set Up a Rally in the Second Half
These stocks substantially outperformed the Nikkei 225 while the China growth story was still intact, but sold off just as strongly on evidence that China’s economy would disappoint on the downside.
While any bottoming and/or tentative recovery in either the US or China economies will come too late to make a significant difference to Japanese corporate profits in FY09—a major sell-off in the yen would immediately be discounted by a sharp rally in the stocks of Japan’s major exporters. Indeed, this is probably the most likely upside surprise.
Japanese China-Related Stocks: Prepped to Outperform Again?
Moreover, year-on-year comparisons from the second half of FY09 will become substantially easier, assuming the absence of heavy valuation losses, restructuring charges and inventory write-downs from the second half of FY08.
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TJI MARKET LETTER 02.09.09
S&P Materials SPDR Tracks the China 65
As can be seen, these stocks are currently very cheap, earnings risk notwithstanding. This indicates that they is already a substantial China/earnings risk discount incorporated in stock prices.
Source: BigCharts.com BHP Billiton and Kawasaki SS Track Each Other
On the other hand, the FXI (China 65), S&P Materials SPDR (XLB), Baltic Dry Index (Bloomberg: BDIY:IND), Australian iron ore majors like BHP Billiton (Bloomberg: BHP:US) and Japanese shippers and trading company stocks track investor sentiment about China growth. So far, these expectations are only tentative, but the volatile BDI has already doubled from December lows, implying that trade that was completely frozen because of the inability to obtain trade financing is beginning to thaw.
Source: Bloomberg.com
In terms of Topix subsectors, shipping has already moved to the front of the line in one-month performance, while wholesale (trading) is still lagging, with only a 5.0% gain for the month.
Consequently, we have put Japanese shippers and trading companies on our watch list, and would be buying these as well as the S&P Materials SPDR, the FXI, BHP Billiton and any other BDI proxy such as the Delta Global Shipping Index ETF (SEA) into the summer months (i.e., after any potential downgrades in 2009 China growth). Japanese Shipper Stocks Track the BDI
Source: Tokyo Stock Exchange Source: Bloomberg.com
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TJI MARKET LETTER 02.09.09
TJI PORTFOLIOS
Sources: Tokyo Stock Exchange, Yahoo Japan Finance Note: The Japan Deep Value Portfolio is a long-term, buy-and-hold portfolio with a 3 year time horizon.
Of the common “save haven” investments shown above, only the Yen, USD bull ETF and Gold have given investors (barely) positive gains YTDr. While China’s FXI is recovering, it is still down YTD. In other words, there has literally been no place to hide in the ongoing financial and economic crisis. Net Buying/Selling by Investor Type
Source: Tokyo Stock Exchange
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TJI MARKET LETTER 02.09.09
TOPIX SECTOR PERFORMANCE
Source: Tokyo Stock Exchange
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TJI MARKET LETTER 02.09.09
Nikkei 225: Looking For Support in US and China Stimulus Packages, Not Japan’s Benchmark Indices and Moving Averages
Foreign investors have all but given up on Japan’s economy and its politicians. Any support for Japanese stocks will come from the US and China stimulus packages, not Japan’s. Hints that China’s stimulus package (introduced last November) is beginning to kick in is recently boosting the BDI and Japanese proxies such as the shippers and the trading companies.
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TJI MARKET LETTER 02.09.09
GLOBAL MARKETS
A glance at the above table shows that there has literally been no place to hide in equity markets, commodities and even in lower quality debt. The only investments that have held their own have been JGBs, gold and the JPY as well as the USD indices. Whether there is another downleg in the cards for equity markets is anyone’s guess, but the risk is definitely there, as the recovery from the October~November 2008 lows has been very anemic, and nothing like the first 100 days of FDR in 1933, when the US market staged a 75% rally. If the US mishandles the current debate about the Obama Administration’s stimulus and bank rescue packages, this could be the catalyst for another downleg, as would a downward revision from current “soft landing” scenarios for China’s GDP. Given recent trading, we suspect there is room for a bear market rally in basic materials, ignited by the hope that China’s economy is already beginning to bottom out. In addition, there is a growing disconnect between gold and crude oil, implying there is potential for a catch-up rally in crude oil, especially under a “China’s not so bad” scenario.
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TJI MARKET LETTER 02.09.09
EXCHANGE RATES AND COMMODITIES
USD Index
Yen Index
Source: Pacific Exchange Rate Service
Source: Pacific Exchange Rate Service
CRB Futures
Source: StockCharts.com
Light Crude
Source: StockCharts.com
Gold
Industrial Metals
Source: StockCharts.com
Source: StockCharts.com
The gold/crude oil ratio has soared in favor of gold. Going forward, the consensus is for gold to reach $1,000/ounce short-term, while we see a correction coming in the continued expansion of the gold/oil ratio—in favor of oil, especially if the conjecture that China’s economy has bottomed begins to take hold. The other set-up developing is a break-out of the US dollar, but is it up or down? Given the miserable economic stats continuing to flow out of Japan, the Yen index is breaking down below its 50-day MA.
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TJI MARKET LETTER 02.09.09
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TJI MARKET LETTER 02.09.09