Despite the recentmarket correction threatening the
four-yearbull market , investors should be partying like it's
Easy-money programs from the world's central banks and a
recovering globaleconomy could pushstocks and other assets
higher. So why is the comparison to 2006 relevant?
September 2006 was two years before the collapse of Lehman
Brothers and a 28% drop in the markets in the span of less than a
month. And two years is about the amount of time we may have
until the next greatmarket crash.
So whatwill be the proverbial straw that breaks the market's
back? Europe? China? Market contagion from a collapse in
None of the above. While the rest of the market worries about
thoseissues , there is a bigger threat that could pull down world
markets and change the way we measure safetyinvestments .
The next great collapse is unlikely to come from any of these
problems. It is more likely to come from a country that has been
a haven for investors for more than 30 years and accounts for
nearly 10% of world growth.
A look at this country'sdebt situation, especially relative to
the United States, is truly amazing.
This country is paying 21% of governmentrevenue on interest
payments tosupport a 236% debt-to-GDP ratio. With annual spending
twice as high as its revenue, the government is running adeficit
of $455 billion ayear and adding to its $11.2 trillion debt. This
is all before the monetary stimulus programs announced recently
by itscentral bank .
If you thought the United States government was a financial
basket case, Japan is exponentially worse. A collapse in the yen
and thestock market is all but certain -- the only question is
The recenteasy money program by the Bank of Japan gives us a good
idea of the timetable.
The announcement by the Bank of Japan to buy 7.5 trillion yen
(about $75 billion) inbonds per month and double the monetary
base during the next two years is exponentially higher than
anything the country has tried in the past two decades. If you
think U.S. Federal Reserve ChairmanBen Bernanke andthe Fed 's $85
billion monthly purchases is extreme, consider that Japan's
economy is a third the size of the United States' and that its
growth has stalled in the past decade.
So the bank wants to increaseinflation to 2% from its current
negative rate of 1%deflation . If they are even partially
successful, interest rates on thegovernment bonds could jump. If
inflation increases to 1% and the rate on the 10-yearbond
increased to just 1.5%, the government would need to pay out 65%
ofrevenues just to service the interest.
Kyle Bass of HaymanAdvisors recently told Barron's that a debt
crisis that will rival Argentina's 2001 collapse is "the most
obvious scenario of my adult life. The question is when."
Japan's stockmarket is up more than 50% since November with
thecurrency depreciating 25% since government officials started
pushing their monetary plans. Just like 2006, everyone is talking
about themoney to be made in the Japanese stock market.
Japan Monetary Base
(trillions of yen)
After two years, the assets held by the Bank of Japan may be
as much as 60% ofGDP , compared with just 25% for the Federal
Reserve. The bank won't be able to sell these assets without
driving up rates, and the government will no longer be able
tofund its massive deficits with the skyrocketing interest
Why should investors care about a country that represents less
than 10% of global growth? Toput Japan's importance in
perspective, Greece's economy is less than one-twentieth of
Japan's -- and brought the market to its knees last year.
Like the 10-yearTreasury note , Japan'sgovernment bond has been
used by the market to evaluate risk for more than 30 years. A
collapse in this market could send shockwaves across markets
Why do I think the scenario could play out over two years?
The Bank of Japan's monetary program will involve buying most of
the government's bond issuance for the next two years, which
should help keep rates down. As the program winds down, the bond
issues are unlikely to attract many buyers, sending rates higher.
The government won't be able to pay the high interest burden, and
the Bank of Japan will not be able to sell its bonds to fight
The analogy to 2006 almost certainly will not play out along the
same two-year timetable, however. The Bank of Japan's monetary
program covers two years. The stock market is fairly reliable as
a six-month predictor of the economy, so investors could start
running for the exits in as little as a year and a half.
Of course, anyone jumping out of the market in 2006 would have
missed out on the remainder of the bull market. The trick is to
ride the market further -- while gradually rotating into safer
names and assets.
iShares MSCI JapanIndex (
is up 30% since its November 2012 low, but it has underperformed
the S&P 500 by 74% since its launch in 1996, with a 31% loss
in that time. The fund is extremely expensive at 21.5 times
trailingearnings and may have a tough time adding togains .
U.S. automakers like
General Motors (
have more to lose than most other domestic companies. The yen
could collapse along with the financial system, which could make
Japanese exports cheap compared with those of international
While Japanese automakers like
have factories set up internationally, the country still exports
about 1.5 million cars a year to the United States. As the yen
weakens, these companies may shift more production back to the
mainland, driving the cost of Japanese vehicles down further.
CurrencyShares Japanese Yen Trust (
, down almost 20% since November, could eventually implode as a
debt crisis ruins the currency's status as a safe haven and
massivedepreciation follows. Investors may be able to use the
fund as ahedge against market losses in their portfolio if a
collapse does happen.
Risks to Consider:
As the greateconomist John Maynard Keynes said, "Markets can
stay irrational longer than you can stay solvent" -- so shorting
the Japanese market may not be recommended as the bubble
inflates. Japan is still the third-largest global economic power,
and it could stave off the inevitable for a couple of years.
Action to Take -->
I firmly believe this event could send the world into arecession
. Japanese stocks and the yen could be the hardest-hit, and
shorting them may provide a good hedge against drops in other
markets. Take your profits on Japaneseequities and keep the
situation on your radar.
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