INVESTMENT FOCUS-Japanese markets shiver as China slows, investors dodge risk

By Natsuko Waki

LONDON, March 28 (Reuters) – Japan’s financial markets face
a challenging new fiscal year as economic slowdown in its
emerging trading partners and a sales tax hike at home push
risk-shy investors into cash-like assets.

Almost a year after Japan unleashed the world’s most
intensive burst of monetary stimulus, the benchmark Nikkei index
stands at the bottom of the 2014 performance league,
falling 7 percent to be the biggest losing asset after copper.

Portfolio flows also point to investors shedding risk.
Foreign investors, who dominate more than two thirds of daily
liquidity, sold a net 191.0 billion yen ($1.87 billion) of
shares in the latest week, after selling a record 1.1 trillion
yen the week before.

Domestic investors have also been selling their foreign
equity and bond investments and bringing the money back home,
especially before the fiscal year ends on March 31.

A dramatic mood change towards Japan goes beyond natural
underperformance after a bumper 2013, when stocks rose more than
30 percent. The biggest drag is a slowdown in China, Japan’s
main trading partner, which hurts Japan Inc’s profitability.

Moreover, emerging market volatility and geopolitical risks,
along with the yen’s rise, have prompted foreign and domestic
investors to sell Japanese stocks, spurred by next week’s tax

“Japan is starting to suffer from emerging market fallout.
The second quarter is a real test for the Chinese and Japanese
economies,” said Mike Howell, managing director of CrossBorder
Capital (Other OTC: CGHCnews) .

CrossBorder’s index of aggregate liquidity – flow of cash
and credit – in the private sector dropped to 52.5 at
end-February, a decline of 36 percent from a May peak.

“The corporate sector is having a hiccup in terms of its
cash generation, either because sales are weak or costs are
higher,” Howell said.

He estimated around half of foreign portfolio flows goes
into currency-neutral futures, while the rest goes into
yen-denominated exchange-traded funds or physical shares.

“If you buy ETFs or the yen-denominated Nikkei, clearly you
have currency risks. If there’s no recovery in private sector
cash flow, we’re unlikely to see a strong rebound in stock
markets unless the BOJ eases further or the yen devalues.”

Japan’s deteriorating current account position also confirms
weak exports and reduced private sector cash flows.

The current account logged a record deficit in January as a
weak yen and consumption before the tax hike drove up imports,
already elevated by demand for fossil fuel to make up for
nuclear energy lost since the 2011 Fukushima disaster.


It’s not just foreign investors who are risk-averse. The
BOJ’s quantitative and qualitative easing (QQE) has yet to have
its intended impact of driving Japanese investors out of
low-risk Japanese government bonds.

Daiwa Capital Markets cites the BOJ’s data showing insurance
firms and pension funds remained net buyers of JGBs in the
fourth quarter, leaving JGBs as the largest share of their
financial assets at 45 percent and 24 percent respectively.

“There remains little evidence of the major portfolio
rebalancing that ought to happen if and when Japanese investors
truly believe that QQE is shifting Japan’s economy back on to
the path of sustainable growth and inflation,” Daiwa said.

Japanese corporates are also holding near record amounts of
cash on their balance sheets. They currently have around $942
billion of cash and equivalents, up 32 percent from end-2008
levels, according to Thomson Reuters (Frankfurt: TOC.Fnews) data.

According to a poll by Bank of America Merrill Lynch, fund
managers are a net 16 percent overweight on Japanese stocks, a
12-month low, and they think short yen is the most crowded trade
in global markets.

Around one in three investors polled by Barclays Capital
said the macro trade in Japan had largely run its course, while
they still liked long equity and short yen positions.

“There appears to be increasing market doubt over the
sustainability of the Japan trade,” Barclays (LSE: BARC.Lnews) said in a note.

It said the next stage will include less emphasis on short
yen but potential outperformance of small cap domestic equities
and strategic short JGBs.

“Over the longer term, we can expect less dependence on
foreign flows as domestic investors gradually shift asset
allocation in favour of equities if the economy continues to
reflate,” it said.
($1 = 102.1350 Japanese yen)

(Editing by Ruth Pitchford)

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INVESTMENT FOCUS-Japanese markets shiver as China slows, investors dodge risk
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