Geopolitical Developments: The Doom Loop Of Japan Inc. Starts With The Japanese State

Growing statism is a primary fear among market participants and one that is silently underlying the bear market of 2022. Statism in America found shape in the Biden stimulus bills that have exacerbated roaring inflation, but statism across Eurasia and the Middle East is even more troubling as it harkens back to totalitarian days of yore. One country long used to a strong and intrusive state is Japan, and if the last 22 years of stagnation weren’t proof of the bleak consequences of statism then the ongoing deterioration in the ¥ may finally awaken that nation to its disastrous political choice. The ¥’s decline is part of the global economic falloff as it makes imports of energy and other commodities that much more expensive, and this week’s parabolic moves in the $US signal financial and political trouble ahead. For now, however, investors are debating whether the bear market rally still has legs. The volatility risk premium points to a market fall over the next few days but my technical reading of key stocks in the S&P 500 is neutral. There are several negative factors across global asset classes. The action in currencies signifies $US strength. The US yield curve is rising and in the current context that is bearish. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days before the bears win the debate and send equity markets careening downward.

Japanification is the demographic doom loop that many forecasters see happening to China, Russia, Germany and America. And this week that scenario is looking more ominous as the Yen resumes its downtrend while the country reels from the aftermath of the Shinzo Abe assassination. Few expected much from the current Liberal Democratic Prime Minister, as he is largely cut from the same cloth as the last 17 PMs that have ruled since the bursting of the bubble economy on December 31, 1989. But no one expected the assassination to damage the reputation of the LDP, when one would normally expect a surge of sympathy. The mood music of Japan continues its decrescendo as this once proud nation deals yet again with unwelcome foreign influences while simultaneously watching its domestic population drop.

The Yen is an obvious benchmark for confidence within Japan, but even more troubling is the possibility that foreign holders will lose confidence and resurrect an Asian Financial Crisis. MarketWatch notes “Carl Weinberg, founder and chief economist at High Frequency Economics, warned this week that Japan’s widening trade gap risked sparking a downward spiral in the yen that would be extremely out of character for a major world currency. We cannot put a point on it, but we fear Japan is headed toward a point not too far down the road where its yen comes into excess supply,” he wrote in a note to clients. “After all, what can one do with a bag full of yen?”

Japan no longer runs a trade surplus and its currency is more tied to earnings from abroad than to exports from Sony and Honda. And since the Japanese are used to deflation there is a propensity to save rather than spend, which means the Yen loses both from limited demand at home to moribund equity markets around the world. But Japan has also injected its fiscal and monetary policy into its equity markets, and that leads to the fear among foreign investors that there is only one real buyer of Japanese assets they can count on, and the vulnerability of their holdings should the government stop buying. MarketWatch further notes:

“Hypothetically, a downward spiral of the yen could trigger a currency crisis like the 1997 Asian Financial Crisis, when the collapse of the Thai baht triggered a wave of currency devaluations, debt crises and foreign capital flight across East and Southeast Asia, although Weinberg didn’t go that far…Weinberg’s fear is that Japan’s trade deficit could leave foreign investors holding more yen than they are willing to reinvest in Japanese government debt or stocks.”

A replay of the AFC is all the world needs right now, and adds to the potpourri of horrific risks besetting global markets. Consequently I see the bear market resuming soon as we head into the seasonally bearish months of September and October.

My current positions are a moderate but relatively large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the levered ETFs UPRO and SPXU.