"How many things we regarded yesterday as articles of faith that seem to us only fables today?"
- MICHEL DE MONTAIGNE, FRENCH RENAISSANCE PHILOSOPHER
Land of the setting yen? After nearly 34 years in the investment business, one strongly and widely held view—clutched with almost religious fervor by millions of investors, academics, and policymakers—still leaves me incredulous: the belief that markets are efficient. Unquestionably, markets are often reasonably accurate processors of available information. But, as Warren Buffett has observed, there is a vast difference in believing they are usually efficient and believing they are always efficient.
My perception is that almost countless biases and misconceptions frequently distort market valuations. Often, these can go on long enough that they become essentially self-validating. The long-lasting bubbles in tech stocks in the late 1990s and real estate from 2004 through 2007 are merely two examples. The longer these stay inflated the more rationales are created to justify their continuation. And, after all, bubbles are a blast—until they blast apart.
Kyle Bass was one of the handful of hedge fund operators to get the sub-prime mortgage disaster right. His short positions in that now-infamous asset class made a fortune for his investors and, naturally, given the usual "2 and 20" hedge fund structure, himself. (If I sound a tad jealous given that Evergreen is a "1 and 0" traditional money manager, well, I am only human!)
Recently, though, Kyle, like many of those who hit the jackpot on "The Big Short," has struggled with some of his current bets. To wit, Mr. Bass has been a frequent guest on CNBC explaining why he thinks Japanese bonds are a massive bubble on a collision course with a sharp instrument. Yet, despite compelling reasoning, it continues to further inflate and has, thus far, remarkably avoided bumping into even the slenderest needle.
Similarly, one of the craziest broadly held beliefs, in my opinion, is that the Japanese currency is a safe haven. Thus, whenever something bad happens (and given the perilous state of the world these days, that’s a fairly recurring event), the yen rallies. This also tends to support Japan’s bond market where the sub-1% yield on its 10-year government debt makes US Treasury rates seem positively mouth-watering. The incongruity of the yen being seen as a safe harbor given Japan’s rapidly eroding fiscal condition, an abysmal economic growth rate, and disastrous demographics is right up there, in terms of nonsensical investment conclusions, with believing that housing prices never go down.
In this month’s guest EVA, our good friend and close ally, Grant Williams, weighs in on this subject. I think you will find his reasoning of why this bubble is close to its implosion point to be most fascinating.
THINGS THAT MAKE YOU GO HMMM...
he Government Pension Investment Fund, Japan (GPIF) does pretty much exactly what it says on the tin, i.e. it is the pension fund for Japanese public sector employees.
It is also the largest such institution in the world and has assets under management that total a truly staggering ¥108 trillion ($1.5 trillion). To put that sum in perspective, it is roughly the same as the GDP of Canada... or Russia.
The first three quarters of 2011 weren’t so kind to GPIF, unfortunately, and, as at December 31, 2011 (the Japanese fiscal year ends on March 31) their AUM (assets under management) had shrunk by a not insignificant ¥2.87 trillion or 2.54% (to continue the GDP comparison, that is like vaporizing the entire Lithuanian economy in nine months). Not good.
A look at the performance of the various investments held by the GPIF demonstrates just how hard it is to invest in the current environment as they showed losses in domestic stocks (-15%), international stocks (-16%) and international bonds (-4%). Fortunately, the one bright spot in their portfolio happened to be their single largest allocation; domestic bonds, which gained a comparatively whopping 2.5%.
A look at the breakdown of GPIF’s portfolio is highly illustrative (See Figure 1):
As you can see, almost 70% of the ¥108 trillion in the GPIF’s coffers is sitting in domestic bonds.
That’s roughly ¥75 trillion or $1 trillion in Japanese bonds which sat quietly on GPIF’s balance sheet.
Historically, GPIF has been one of the largest buyers of Japanese government debt and has done more than its fair share to confound those who have predicted Japan’s day of reckoning; including Kyle Bass who has been waiting an awfully long time for his view on Japan to play out as he expected.
In his letter to investors dated November 2011, Bass wrote:
We believe the debts of the following nations, among others, are not sustainable in the current economic environment: Greece, Italy, Japan, Ireland, Iceland, Japan, Spain, Belgium, Japan, Portugal, France and, have we mentioned Japan?
No mixed messages there.
As can be seen from the names on that list, despite Japan’s stubborn refusal to play ball, Kyle still has a pretty good batting average, but on Thursday, his chances of looking very good indeed increased significantly when one of Japan’s biggest poachers announced that they had turned gamekeeper, or, more accurately, one of Japan’s biggest buyers of government debt had rather troublingly, turned seller:
(Bloomberg): Japan’s public pension fund, the world’s largest, said it has been selling domestic government bonds as the number of people eligible for retirement payments increases.
"Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash," said Takahiro Mitani, president of the Government Pension Investment Fund... "To boost returns, we may have to consider investing in new assets beyond conventional ones," he said in an interview in Tokyo yesterday... The fund needs to raise about 8.87 trillion yen this fiscal year, Mitani said in an interview in April. As part of its effort to diversify assets and generate higher returns, GPIF recently started investing in emerging market stocks.
Japan’s demographic nightmare has always been the bedrock of the case outlining why the country’s massive debt—accumulated over twenty painful years—would eventually cripple it, but the problem with demographics as an investment case is that most people can’t even begin to think that far ahead and will readily assume that, because such events are decades in the future, they will be solved long before they become a real problem.
Let’s take a look at the dynamics (for want of a better word) of Japan’s population.
According to official figures published in July 2011, the population of Japan is 127,368,088 (quite an accurate