I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Monday Money, I write about money management.
Yesterday, Japan’s new prime minister Sanae Takaichi’s gamble to call a snap election paid off. Her Liberal Democratic Party (LDP) formed a coalition with the Japan Innovation Party and won a supermajority in the lower house of Japan’s parliament.
Some terminology: a simple majority is just over half (more than 50%) of votes or seats. A supermajority is a higher threshold, often two-thirds or three-fifths of the total, required for more consequential decisions. LDP won 316 seats by early Monday, and the Japan Innovation party won 36 seats, out of a total of 465. Takaichi now commands more than the two-thirds of the seats she needs to override the upper chamber of Japan’s parliament, which is not under her control.
I wrote at length about what possible scenarios could play out about this on Reckless Investing. This morning we see some earlly reactions, in the markets and among pundits.
Pundits
via Twitter, the idea that the Japanese yen may strengthen here is not apparently such an unpopular opinion:
The case for yen weakening would go like this. Takaichi, with the backing of her house of representatives, leans into spending such as consumer stimulus, defense spending, and industrial subsidies while keeping rates low (yield curve control, possibly). Larger fiscal deficits and more JGB issuance are required. This combination, fiscal dominance where fiscal policy wags the treasury and central bank dogs, leads to a weakening currency. Inflation would result and real yields would stay unattractive.
Meanwhile, the U.S. Fed may stay restrictive longer than expected. US real yields could remain high. The carry trade remains attractive. Institutional investors will borrow yen to buy USD assets. That would keep the yen structurally weak even if Japanese yields rise.
Meanwhile, domestic Japanese investors might not repatriate their money. This includes pension funds, insurers, and households who have spent decades learning to look elsewhere than JGBs for fixed income returns that outpace inflation.
Equity strength could weaken the yen, if foreign investors buy Japanese equities but hoose to hedge FX exposure through short-JPY positioning.
And meanwhile, governments often prefer to keep their currencies relatively cheap, to support exporters, raise nominal growth, and help with debt sustainability. Takaichi has very little incentive to engineer a strong currency in absence of politically toxic inflation levels.
In the markets
The Nikkei 225 index was up almost 4% in Japan’s Monday session after the elections. The Yen is strengthening, with USDJPY down 0.56% as of right now, 8 am mountain time. (USDJPY records how many yen a dollar will buy, so a decrease in that represents a strengthening of the yen).
The narrative for a stronger yen goes like this: rising JBG yields, the end of yield curve control as a default, Japan as the last cheap developed equity market, and risk-parity / vol targeting strategies will result in a reallocation of capital towards Japan.
Global investors are underweight Japan right now. Japan is about 5-6% of the MSCI All Country World Index (ACWI) and 20-22% of the MSCI World (ex-US). Many U.S.-based global equity portfolios hold only 2-3% Japan exposure and some old effectively zero is they are overweight US tech and have given up on Japan after decades of underperformance.
Japan’s recent rally has occurred against a backdrop of poor sentiment and persistent underweighting. In this setting, equity inflows and FX repricing remain plausible, even if Takaichi’s government will have, like every debt-ridden developed market government, the incentive to inflate her way out of Japan’s problems.
Japan owns much of its own debt, giving it more policy flexibility than a net-debtor nation like the U.S., where foreign demand plays a larger role at the margin. Recent reports that Chinese regulators are urging banks to limit U.S. Treasury exposure underscore this difference: Japan’s debt is largely an internal affair, while U.S. financing conditions remain more sensitive to foreign portfolio decisions.
Getting exposure to Japan stocks
I prefer broad ETFs to single-region funds, so I lean towards including broad developed market ex-U.S. to a Japan-specific fund.
I hold $PXF and $SCHF in my non-retirement account.
- $PXF – Invesco FTSE RAFI Developed Markets ex-U.S. – a value fund – has a bit more than 20% Japan exposure
- $SCHF – Schwab International Equity ETF – a market cap weighted fund holding both growth and value stocks has 20% Japan exposure
I don’t hold $EFG the iShares MSCI EAFE Growth ETF, but it has a bit more than 20% Japan exposure too. So it seems with any international developed market ex-U.S. fund you will be allocating about 20% of that to Japanese equities.
Right now the international funds are a bit overstretched and volatile, so now might not be the time to make any big moves into them. But this is an area I’m adding to, especially as Europe also looks pretty good with its increased defense spending and ongoing decoupling from the U.S.
This is not financial advice. I’m an individual investor sharing my experiences and learning. This information is for education and entertainment purposes only.