The yen and Japanese equities in historical perspective

- The yen has risen roughly 4.2x in the last 40 years
Yen to get stuck in ¥70/$-¥80/$ range? — "Yen strengthening is not something that suddenly started yesterday. Since the fixed exchange rate system came to an end in 1971, the yen has risen 4.2x against the US dollar. We need to look at a risk scenario in which US long-term interest rates fall, the yen strengthens, and share prices remain depressed."
A strengthening yen is a long-term trend — "The yen’s nominal effective exchange rate rose 4.56x against the US dollar in the four decades or so from January 1970 to end-July 2010. In the space of the 39 years from August 1971, when the yen was at ¥360/$ (a fixed rate), the Japanese currency has risen 4.24x to ¥85/$."
Why the yen has risen long term — "Japan’s current account-to-GDP surplus has historically been high. In recent years, while the balance of trade surplus has been shrinking, net factor income (income from investments made abroad, etc.) has been rising. In 2009, the current account surplus was ¥13.2trn, with the income surplus coming in at ¥12.3trn."
Japan, overseas interest rate differentials narrowing — "The balance of overseas securities investments rose to ¥262trn at end-2009 from ¥131trn at end-1999, with the balance of overseas net assets rising over the same period to ¥266trn from ¥84trn. These increases in capital transactions are exacerbating the impact of Japanese and overseas interest rate differentials on the forex market."
US interest rates in long-term decline — "Over the long run, we believe the falling US nominal growth rate is causing long-term US interest rates to decline. The peak in the US nominal growth rate came in 1978 at 13.0% (real growth rate of 5.6%, CPI growth of 7.6%)."
Powerful downward pressure on interest rates in the near term, too — "We expect US core inflation to be weak for a while, due to the decline in rents. We also think tax increases are likely to be implemented as proposed. We thus conclude that rebounds for US long-term interest rates, the dollar versus the yen, and Japanese equities will depend on us seeing some positive metrics for the US economy."


- Turning point will not be policy but a bottom for the US economy
No hopes for policy action — "The BoJ has decided to supply around ¥10trn in new funds to the market. This equivalent to no more than 0.7% of broadly defined liquidity (¥1,455trn). The fiscal response is also likely to be a drop in the ocean. We doubt there will be any big changes in the near term to the weak US economy, declines in long-term US interest rates, yen strength, and low share prices."
No prospect of bold forex intervention — "The Obama administration is aiming to significantly shrink the US fiscal deficit and at the same time is adopting a strategy of promoting exports to grow the economy. We think that President Obama, who with a support rate of around 45% and 50% of voters opposed to him is finding his popularity flagging, would actually welcome steady dollar weakening."
Overshoot — "We feel investors need to keep in mind a risk scenario in which the markets overshoot, with the yen surging into the ¥70/$-¥80/$ range, US long-term interest rates plummeting into the 1%-2% range, and the Nikkei tumbling to around 8,000. However, our base case is for rising US long-term interest rates, yen weakness, and rebounding Japanese equities over the longer run."
Advantages of lower interest rates — "We recommend investing in real estate, tourism, and telecom stocks, domestic-demand plays that benefit from deregulation. We think additional monetary easing and falling long-term interest rates will benefit companies such as Sumitomo Realty & Development, All Nippon Airways, Central Japan Railway, and SoftBank, which have relatively low shareholders’ equity ratios."
Asia-related names have been doing well — "In August, it was domestic-demand stocks that outperformed, with global cyclicals and exporters suffering big pullbacks. Even though export-related names were slack overall, the shares of Asia-related names such as Daihatsu Motor and Isuzu Motors were relatively strong."
Resource and energy names — "There is not infrequently an inverse correlation between the dollar’s real effective exchange rate and the real price of crude. For investors expecting a fall in the dollar, we think it would be desirable to increase holdings of resource and energy names such as Sumitomo Metal Mining and Mitsubishi Corp."


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