Market Talk #1 – Stocks and Bonds

Posted by Tokyo MadHatter on January 05, 2009

It has been a few years since the Tokyo MadHatter last wrote publicly about markets, but we’ve been watching things from the quiet backwaters of a cash flow strong industry sector here in Japan that has very little exposure to global financial markets.

However, as this recession has started to affect the citizens of Japan, and you our dear readers that reside here, we felt it was necessary to come out of retirement and give you the heads up on what is really happening in global markets, with an obvious focus on the stock market. You have to have a knack of reading between the lines, but don’t worry, the Mad Dog team is here to decipher the decipherable and give you the gist so that you can plan how best to get through the next few years.

So, without further ado, let me recap on some recent news and what it means to all of us.

As we head towards the end of the year, the Tokyo stock market has been falling for some time, around 48% since January. Classic economists will say “supply is greater than demand” so stock prices will fall. Ok, great comment from the new kid on the trading desk. Why?

“Foreigners are selling”, a common refrain from domestic investors. Again less than useful to understand what is truly going on.

“Forced selling, liquidations, loss cutting…” now heading in the right direction, gritty words, but starting to give a glimmer of reality to our conversation with the newbie.

That is about the level of sophistication that the market pros speak in as well though, not much of a pertinent indicator for how the Nikkei falling and the snowballing effect of this economic hardship are affecting everyday folks like you and me. But worse is to come, and you are likely to get some arcane details or discussions that normal people wouldn’t hear in the course of normal life. By this I mean when it comes to explaining how they have managed your money, the excuses really start to roll. “Unprecedented” credit market shocks, “black swans”, “once in a hundred year event” as if they can regain your trust for destroying their wealth with a few platitudes.

The fact that major manufacturers like Toyota cutting back on jobs on the front page of the Nikkei as has been pointed out by many commentators is grim reading. But dear readers, you have to keep all this in perspective, and we posit to you that in the big cycles, the following is happening.

Japan had a credit bust in the nineties. To allieviate the ultimate painful repricing of assets and slowly let the lid down, rather than suddenly as used to happen in historical bubbles bursting, the BoJ flooded cash markets with cash, reducing yen interest rates to record lows. None of that helped reflate the domestic bubble, and in fact, a lot of that flowed overseas in the now infamous “carry trade”.

In fact, we believe that this is what underpinned the extraordinary credit growth in financial securities and aided Greenspan in his inept mis- management of US monetary policy for those long 18 years he was blowing credit bubbles all around the US economy, and in effect the global economy.

Now from the new century, the Japanese asset prices which had been in free fall were starting to bottom out and starting to be worth something on a real basis, ie a real yield. Suddenly before you could say “private equity” the foreign investment banks were snapping up all sorts of assets on the cheap, generally by leveraging them up and in a cheeky way showing domestic investors that it was time to come out of their trenches where they had hunkered down for too long. Now, where did all this money come from, well, if it hadn’t been for the extraordinarily cheap BoJ money slushing around the economy, we wouldn’t have had the mini bubble in Japan, or more precisely Tokyo, especially Minato-ku property, and the Nikkei definitely wouldn’t have reached the lofty levels on 18,000 it was trading at last year.

So, the assets change hands, there are the real assets like property and there are the paper assets like stocks or bonds. First, the foreigners buy the assets as they had the “liquidity preference for risk assets”, while domestic investors were hunkering down in deposit type investments hoping they wouldn’t lose any more money. This is what was happening around 1999/2000/2001. Now in 2008 and more in 2009, the foreign money is fleeing but it is really too late to get a good price on that and the buyers of last resort are now the domestic investors.

That is the great thing about a lot of these assets, you can’t take them away with you so you have to dump them for whatever the locals are willing to pay for them. In this case not a lot, because the Japanese investors unfortunately have a lot of dross of worthless assets they purchased overseas and in a mirror image are repatriating their capital back to Japan.

So, right now, we are in the start of a big liquidation period, where cash will return or at least part of it will return to its owners and those who leveraged up to buy assets will be in trouble because suddenly, there is no other investor out there to pick up the stock / building / investment property at the same price that might have seemed reasonable 12-18 months ago.

I am sorry to say, but the news is bad, and it only gets worse, for most people. Bubbles are fun, everyone seems to be making money. As the famous Paul Volcker who ran the US Federal Reserve Bank in the 1980s was famously quoted, the job of a good central banker is to take the punchbowl away at the party. It is never a popular role, and that is why his tenure wasn’t extended for another 6 years compared to his successor who made himself famous for filling up the punchbowl during the middle of the party, and in effect letting the party run on all night.

Right now, stocks and bonds are only for the brave, cash is good and precious metals are best.

Tags: bonds, Stock Market, stocks, the market

Filed in Personal Finance