Chart of the Day: JPY Forecast Model in the Money

The Model

Custom Products Research uses 5 regression models to forecast fair value for the USDJPY exchange rate. As of January 25, 2017 the fair value for USDJPY was ¥112.65, based on our main 3-Equation model (3EQ).  We had also forecast ¥114.51 based on the US-Japan 2-Yr 1 YR forward spread differential (2Y1YF) and ¥111.03 based on the inflation expectation-adjusted 2 YR US-Japan real rate spreads (IA2YS). The 5 regression models all have very high R2 with the 3 equation model at 89%, R= .944 and t-stat 121 over the last 7 years.  The inflation expectation adjusted 2 yr yield gap R2 is 90.8% over 5 years, R95% and t-stat 60.2. While the 2-Yr 1 YR forward spread has an R2 of 87% and R93% with t-stat 25.7 over last 2 years, but this falls over a longer timeframe. (for further details see January 31 report, ‘Exchange Rate Forecast…..’)

As of 1AM GMT February 24, 2017,  both  2Y1YF and 1A2YS indicated USDJPY fair value ¥112.90, which happened to be exactly the spot rate. While our 3-equation model stood at ¥111.92.

What has Changed?

Over the last month, 2-Yr yield spreads have remained unchanged at 145bps, while 2 and 3-YR inflation adjusted spreads have become more negative (-60bps to -100bps), implying a stronger Yen. Real adjusted 10-Yr rate spreads have also declined, from 0.6% to 0.09%, also implying a stronger Yen. Meanwhile inflation expectation-adjusted short-term yields have been flat. Similarly, the 2 YR 1-YR Forward rate differential has been flat at 1.9%, after having risen from 1.4% in October. 

The Outlook

We still expect the Yen to weaken towards year end, based on 4 quarter-point hikes by the Fed. (see January 1 report ‘Central Bank Policy: Fed Still Behind the Curve). Q1 GDP growth should be between 2.4-2.5%, Hourly wage growth is also 2.5% and the Bloomberg Economic Diffusion Index continues at a high level. January CPI was 2.3%, with continued upward pressure from oil and China producer pricing, supporting our ‘inflation surprise shock’ scenario. 

Unfortunately, as the BOJ is content with 1% real GDP growth and USDJPY above ¥110, no further rate cuts are expected from the BOJ (see February 17, 2017 report ‘Central Bank Policy – Why 2018 is Looking a Lot Like 2006 for the BOJ’)

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What Worked Japan - 02 Dec 2016 - Value and High Beta names continue to do well since the beginning of October

What Worked  Value names did really well this week and have actually done well since the end of September. This week low PBR names dominated with an almost 50% IC.  A good portion of the low PBR names that did well were in the Bank Sector. Low PBR names that did well were Nomura Holdings (8604) up 12%, Iyo (8385) up 10% and Idemitsu Kosan (5019) up 9%.

Low PE names also did well this week. Low PE names that moved were TADANO (6395) up 10%, Resona Holdings (8308) up 10% and Concordia Financial Group (7186) up 9%. Quality names however continue to underperform. High ROIC names have not done well since the beginning of October. High ROIC names that were down were MonotaRo (3064) down 9%, M3 (2413) down 9% and Hitachi High-Technology (8036) down 8%. As with Value, high Beta names did well this week and have done well since the beginning of October. Panasonic (6752) is up 9% and Mitsubishi UFJ Financial (8306) is up 10%.

Who Moved – 67 names moved on volume this week. A pretty good number for Japan. Only 14 of those names were down this week. On the positive side, Sumitomo Bakelite (4203) was up 11%, Iyo Bank (8385) was up 10% and Sumitomo Mitsui Construction (1821) was up 8%. On the other side, Santen Pharmaceutical (4536) was down 9%, Terumo Corp (4543) was down 4% and Misumi Group (9962) was down 5%.


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Crime in Japan - Part 3 - Fraud, Drugs, Murder, Yakuza & The Police

Crime doesn’t pay unless you are a gangster over the last decade…

Full report available here

In our Crime in Japan series parts 1 & 2  we covered the jump in crime resulting from seniors breaking into prison and the rapid breakdown in the nuclear family leading to a surge in domestic violence and child abuse. In this report we cast our focus on the resources of the police and whether the change in crime is impacting their ability to hunt down Yakuza (gangsters), thwart drug use and possession, prevent murder and stop the leap in financial crime where insurance fraud alone is up 2,000% in 6 years and suspicious transactions breaking new records.

The Japanese National Police Agency (JNPA) has been the victim of budget cutbacks. Some 80% of the ¥3.2 trillion budget is spoken for by staff salaries. There are approximately 295,000 staff (including administration) but actual officer numbers have remained relatively stagnant at around 258,000. With an aging police force, retirees are putting pressure on hiring new recruits. Japan does have a low level of crime on a global basis and 197 police per 100,000 citizens reflects that.

Japan has budgeted approximately ¥232 billion to run its jails in 2016. The cost of incarceration runs to around ¥3.8mn per inmate which is around double what one could get through the welfare system. The theft of a ¥500 sandwich could lead to a ¥8mn tax bill to provide for a 2 year sentence. Courts are dealing out harsher sentences however drug related offences generally range inside 2 years behind bars. Many Japanese have been in the media crossfire for repeated drug offences and the courts have had no choice but to incarcerate them when ‘good behaviour’ probation periods have failed. Prison capacity has grown 50% in the last decade to meet the coming crime wave.

Drugs in Japan are an interesting topic. Meth was originally synthesised from ephedrine in 1893 by a Japanese chemist Dr. Nagayoshi Nagai. 26 years later, a pharmacologist by the name of Akira Ogata managed to turn it into crystalline form i.e. crystal meth.

When World War II got under way Japanese soldiers (especially kamikaze pilots) were given crystal meth (branded Hiropon) which not only kept them ‘wired’ but reduced hunger. As the war ended, Japan was left with excess supplies of Hiropon. Food supplies were few and returning soldiers added to the shortage. However little was known of the side effects and the government had an epidemic on its hands in the late 1940s. Luckily there is a solution being developed by the Japanese biotech company MediciNova (4875) which is in late stage trials in the US with a formula that weans drug users from their addiction.

One of the surprising statistics has been the trend in gangster (Yakuza) incarceration in Japan. While police have seen a surge in consultations (aka complaints) surrounding gangster activity, arrest rates have fallen by 30%. Is it because the police are so tied down by the surge in stalking, domestic violence, child abuse and larcenous geriatrics?

People with mental disabilities committing crime are also rising sharply, up 62% in the last decade. Apart from schizophrenia or medically diagnosed mental health issues, addiction to alcohol or substance abuse can also get an offender classified as mentally disable if they break the law.

Financial crime is becoming far more prevalent. From petty scams to sophisticated insurance and bank fraud, such offences are surging. Reported fraud related to bank transfers has doubled between 2010 and 2014 to 13,400 cases with the amount of money transacted surging 5-fold to ¥56.5bn.

Source: Japan National Police Agency (JNPA)

Murder rates in Japan have remained relatively mute. The homicide rate in 2014 was 938 down from 1362 in 2006. As a ratio, Japan has 0.7 murders for 100,000 people versus 91 for Honduras (the highest) or 4.7 in the US. However Japan has not been immune to home grown massacres.

Foreigners as a percentage of crime in Japan continues its long downward march. Much of the crime is related to petty theft and visa overstays. Chinese, Vietnamese and Brazilians make up 60% of foreigner arrests in Japan. Foreigners as a percentage of inmates has also dropped sharply from 8% of the prison population to 5.5%. Chinese, Brazilians and Iranians make up half of gaijin inmates.

The incidence of crime continues to rise in Japan. As discussed in our previous reports we can see that crime rates (e.g. shoplifting, theft, child abuse, domestic violence, assault, stalking etc.), while small on a global scale, are rising at such a speed it seems to be taxing a police force struggling with worsening manpower issues. It would seem to make sense that despite growing reports of suspicious activity by organised crime, arrest rates are falling. Furthermore retiring demographics in the police force suggest that ‘street knowledge’ gained through decades of leads (e.g. informants) may not so easily be transferred to the new recruits. Throw financial fraud increasingly perpetrated by cyber criminals on top, perhaps the Police need to invest in sophisticated systems rather than just hire more cops on the beat? The face of crime has changed.

Full report available here

Terrorism in Japan - Suckling on the bosom of (a false sense) of security

Can anyone recognise the person in this picture?

Most foreigners won’t know her. Her name is Fusako Shigenobu. She looks harmless and sweet enough. The girl next door? She is actually the Japanese equivalent of Ulrike Meinhof. Shigenobu founded the Japanese Red Army (JRA) in 1971 at the tender age of 26. The JRA was responsible for a spate of hijackings, hostage takings, airport massacres and bombings in the 1970s and 1980s. It was closely aligned to the Popular Front for the Liberation of Palestine (PFLP). Although she claimed the group disbanded in 2011 it has since been renamed the Movement Rentai. Many are not aware another Japanese terrorist organisation bombed Mitsubishi Heavy Industries HQ in 1974. Aum Shinrikyo is perhaps the freshest in many memories for the 1995 sarin gas attacks on Tokyo’s subway. Japan is a safe country to be sure but that does not mean it is immune to future attacks.

As the tragic news events of the Brussels attack unfolded last week, I was reminded of a recent trip to Hong Kong. The Cathay Pacific check-in counter at Haneda International Airport (Fig.1) had not opened. I was surprised to see that several passengers had left their bags unattended and probably gone off to have lunch or shop. I approached a young policeman (draped in ‘anti-terrorism’ arm-bands and badges on his uniform) who responded that if more bags were left unattended they might act.  I suggested to him that a terrorist organisation would view Japan as a very soft target if security personnel turned an obvious blind eye. In any other country these bags would be immediately deemed suspicious, removed, checked and the passengers admonished for being so ignorant. With the 2019 Rugby World Cup and 2020 Summer Olympics approaching this was an international ‘embarrassment’ as far as airport security protocol went. Airports should be zero tolerance zones.

Fig 1: Haneda International & unattended baggage    

Japan’s two main security firms Secom (9735) and Alsok (2331) are official Olympic partners. However what is the upside to a safe Olympic games? Not much but the downside to any potential ‘terrorist event’ could have large downside for these companies.

A senior Metropolitan Police Department (MPD) spokesman said, “we do not want to provide the kind of heavy-handed security by gun-carrying personnel that was seen at the 2012 London Olympics and 2014 Winter Olympics in Sochi”

The MPD wants a light touch approach and is considering an 80-strong all-women riot squad to be used for crowd control. The MPD said “We hope to provide effective and elegant security by using sophisticated technologies…By mixing hard-line and moderate methods, we also hope to honor the atmosphere of omotenashi hospitality unique to Japan.”

It is completely understandable that the Japanese wish to showcase their world-renowned hospitality but there are better ways to do it. Hello Kitty clad Olympic volunteers make a lot of sense but security is all about showing teeth and AK-47 toting terrorists are unlikely to care about omotenashi moreover take it as a sign of weakness which will ensure Japan a viewed as a soft target.

While Brussels and Paris serve as recent reminders of how vulnerable a public can be, Japan must be careful to not suckle indefinitely on the bosom of false security. As American mountain climber Alison Levine once said,

“Fear is OK. It is complacency that will kill you!”

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When Analysts are confused Price Volatility increases

With Earnings Season just right around the corner we looked for names where there is a high standard deviation in Analyst Estimates. Basically which Companies have analysts estimates all over the place. We then looked back over the last 4 years to see how those “confused” names performed and what happened to volatility over the three months from March 24rd. Aside from last year when there was only a 6% difference in volatility in quintile 5 (highest standard deviation) vs. quintile 1 (lowest standard deviation), quintile 5 volatility was 30% higher than quintile 1 volatility in the previous 3 years.

As you would expected with higher volatility, comes bigger return but positive and negative. Quintile 5, outperformed Quintile 1, three out of the last four years. However in 2012 it was down 16% relative to only 7% for quintile 1. Below I have attached the returns and volatility for the different quintiles.

Quintile Summary

For this season we have highlight names that have a large dispersion of Estimates. We screened for names that 1- five or more Analyst cover the Company. 2- Mkt-Cap above ¥100bn and current FY1 EPS divided by Standard Deviation is greater than 30%. For the ones with the largest standard deviation, they look to have had recently significant declines in EPS forecast over the last couple of months. In the attached file we have also included the historical number for each Company.

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What Worked Japan - 18 Mar 2016 - Slight move into Quality and away from Value / Beta

What Worked While really nothing stood out last week, as for direction this week was only slightly better. There was a slight selloff in Value names and a move into Quality this week. Low FY1 PE names that did poorly were Kaken Pharma down 14%, Nippon Kayaku down 11% and DMG Mori down 10%. High ROE names that outperformed were COLORPL up 15%, up 11% and Matsumotokiyoshi up 8%. Negative momentum looks to be one of the  strongest factor currently driving the market.

Names that went down over the last year continued to go down this week. Sharp was down 12% after being down 41% over the last year, Nippon Kayaku was down 11% and Sumco was down 9%. We also saw a move into Retail names and a slight move away from high Beta and large-cap names. High Retail names that did well were Kokuyo up 10%, OKI Electric Industries up 8% and Tsuruha up 8%. High Beta names that were hurt were Seiko Epson down 9% and Unipres Corp down 8%.

Who Moved Only 15 names moved on volume this week and the majority of the names were down. Only three of the fifteen names move up on volume this week. Morinaga Milk was up 10%, Sangetsu was up 4% and Sumitomo Forestry was flat on the positive side. On the other side, Kaken Pharma was down 14%, Nippon Kayaku was down 11% and NOF Corp was down 5% all on strong volume.


Factor Performance Japan

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Japanese Salaries basically unchanged over the last 10 years

Recently the IMF wrote that Japan needs to increase wages, so we thought we would see if that was true. It is. As the only individual-level Salary data is on a parent-only basis we compared Personnel Expenses to the number of Employees and then aggregated up the data. Interestingly on an aggregate basis the number of Employees (including Temp workers) in Companies with market cap above ¥30bn increased 34% in the last 10 years. This is compared to an increase in Personnel Expenses of 36%. So basically companies have added more people but not increased wages / Salary.

However, if we look at the sector level there is some discrepancy. Industrial Services is a great example. Personnel Expenses are basically flat, while the number of Employees has increased 17% in the last 10 years.  Transportation is basically the same with only a 2% increase in Expenses and a 20% increase in Employees. Energy Minerals is the worst with a 32% increase in Employees and only a 3% increase in Personnel Expenses. Health Services is really the only sector that had a significant increase in Personnel Expenses and not in Employees.

While we are not advocating huge Personnel Expenses, if your Employees do not have money they cannot buy your products. It is the circle of life…..

Japan Wage & Employment Changes by Sector

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What Worked Japan - 11 Mar 2016 - Really nothing compared to last week although slight selloff in Beta

What Worked After last week’s huge Value bounce it looks almost like the market just took a break this week. None of the Value or Quality signals stood out and only a couple of factors exceeded our self-imposed 10% threshold as significant. Stochastic Oscillator had a negative 12% IC. So there was a slight sell off in names up over the last month.

Minebea was down 7% and ASATSU-DK was down 4%. There was also a slight selloff in high Beta names. However this is after a huge positive move for Beta last week. High Beta names that went down this week were Asics down 11%, NSK down 9% and Taiyo Yuden down 8%.

Who Moved – Despite nothing really standing out, 20 names moved on volume this week. On the positive side, Suzuki Motors was up 2%, Sangetsu was up 2% and Komatsu was also up 2%. On the other side, Kansai Electric Power was down 24%, Tokyo Gas was down 6% and Coco-cola East was down 6%.


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What Worked Japan - 04 Mar 2016 - Crazy reversal in Momentum and Beta but the move was not supported by Volume

What Worked Beta and Value bounced up harder this week than they did two weeks ago. Beta has really only worked 4 times since the middle of last October. However, this week Beta came in with a crazy high 46% IC. High Beta names that did well were Sumco up 17%, Alps Electric up 17% and Minebea up 18%. FY1 PE almost did as well as Beta. The last time PE did this well was back in October 2015. Low PE names that were up were IHI up 17%, TDK up 17% and Shinsei was up 14%.

PBR also outperformed this week. Low PBR names that did well were Mitsui OSK up 18%, Inpex up 17% and DMG MORI up 14%. There was a good move into names with a high percent of Foreign Investors. Toshiba was up 20% and Inpex was up 17%. Price reversal was even stronger than Beta this week with a really rarely seen 60% negative IC. Dowa was up 14% and Monotaro was up 14%.

Who Moved – Unfortunately not a lot of names bounced on strong volume. Only 16 names moved on volume this week. On the positive side, Nissan Motors bounced up 13%, Hitachi Capital was up 10% and Zeon was up 10%. On the negative side, overall there were only 74 names with negative returns this week in TPX500.  The ones that were down on volume were NEC down 8%, SCSK Corp down 5% and Odakyu Electric down 4%.


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What Worked Japan - 26 Feb 2016 - Selloff in Value after the strong bounce last week

What WorkedAfter last week’s strong bounce in Beta and Value, this week we saw a moderate selloff in Value and a slight move back into Retail names. Since the middle of October last year we see that PE has one strong week followed by a month or so of underperformance. If that holds true this time we have two more weeks of Value hurting. The last time that PE consistently did well was back in April/May of 2015. Low PE names that did not do well this week were Nippon Shokubai down 11%, Shinsei Bank down 9% and Mitsubishi Gas Chemical down 8%.  Retail names that bounced back were Aiful up 10%, Softbank up 10% and Fujikura also up 10%.

Who MovedCompared to last week, volume really dried up. Only 26 names moved on strong volume, which is about normal for Japan. On the positive side, Central Glass was up 21%, Unipres was up 16% and Trend Micro was up 16%. On the other side, ABC-Mart was down 5%, Temp Holdings was down 4% and Inpex was down 4%.



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