Season Investments

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Micro Update: Japanese Yen

Posted on March 28, 2012

JAPANESE YEN

Japan is the third largest economy in the world behind the United States and the rapidly growing People’s Republic of China. Now considered a fully developed country, what many fail to remember is that only 25 years ago Japan was highly reminiscent of current day China. Growth was going gang busters, and it was commonly speculated that Japan would overtake the United States as the world’s largest economy. However, Japan’s growth cycle peaked shortly thereafter when its debt-induced property bubble burst, leading to a multi-decade bear market for Japanese stocks and real estate. 

In contrast, Japanese bonds and the Yen have fared extremely well over this period in the face of persistent deflation and sluggish economic growth. Strength in the bond market is largely due to Japan’s aging population, which is becoming more heavily skewed to the older end of the spectrum - a trend which is not projected to change as reflected in the chart below. This demographic shift has supplied the Japanese government with a vast supply of “lenders” over the past two decades. As investors, the Japanese are far more conservative than we are in the West, making them more willing to invest in their governments’ long-term bonds yielding 1% or even less at times.

As such, Japanese policy makers have been weak-handed in their attempts to fight off deflation. In order to do so, one must be willing to accept the risk of sparking inflation - something our own Fed Chairman is none too shy about. Since inflation would negatively impact older retirees whose portfolios are heavily skewed toward bonds, pro-inflationary policies have been un-popular in Japan making the multi-decade bull market in their bonds and currency possible.

Deflation has a positive effect on a currency’s value by virtue of the fact that purchasing power will be greater in the future than it is today. Since the Japanese stock market peaked in 1989, the Yen to US Dollar exchange rate has dropped from over 250 to around 80. Put another way, it takes roughly 1/3 the amount of Yen today to purchase a single US Dollar as it did 30 years ago.

The Yen has also acted as a defensive currency due to something called the carry trade. Given the low yields in Japan, a popular strategy has been to borrow money in Japan to purchase bonds in other higher yielding currencies. In “risk off” environments, this carry trade is reversed as investors flock to safety by selling those bonds and converting their currency back into Yen. This causes the Yen to strengthen during periods of high market turbulence. The relative strength of the Yen vs. the Dollar and the Yen’s defensiveness are the two primary reasons we like a long position in the Yen as part of a portfolio built on our Diversification 2.0 philosophy.

Unfortunately, we have experienced a stiff correction in the Yen versus the US Dollar over the past couple weeks. This can be attributed to two primary factors. The first factor was Japan’s trade surplus temporarily shifting to a trade deficit, the largest of which occurred in January of this year. This was driven by increased demand for energy and other raw materials used to rebuild after last year’s earthquake, as well as by the strong Yen making Japanese exports less appealing to foreign investors. This trend has already started to shift as Japan went back to posting a sizeable trade surplus in February. The second factor was the Bank of Japan (BoJ) announcing that they would increase their bond buying program (their version of “quantitative easing”) and target a 1% inflation rate. The market interpreted this as a big shift from the weak policy stance the central bank has historically taken. 

The announcement that the BoJ would start targeting inflation was concerning to us, and in hind-sight we wish we would have given it more credence. We still think that the recent move in the Yen will be reversed as Helicopter Ben will not allow the Japanese to beat him at his own game (e.g. printing money). This thesis was supported on Monday when Bernanke announced that the Fed would continue with their “supportive monetary policy” to speed up growth. Our economy is addicted to stimulus and the easiest way out of the debt bubble we find ourselves in is to devalue our currency. For these reasons, we remain long the Yen for the time being.


We want Transparency to be one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. Regular Macro Updates will address our economic and capital market viewpoints and discuss top-down portfolio positioning. Also watch for Micro Updates which convey our reasoning behind specific investments.

This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.