Nomura Says Buy Protection as Abe Optimism Flags: Japan Credit
Nomura Holdings Inc. says investors should consider buying derivatives protecting bonds of companies focused on Japan’s economy from losses as the nation’s finances worsen.
The brokerage recommends purchasing credit-default swaps on companies such as Sumitomo Realty & Development Co. and Kintetsu Corp. as the benefits of Prime Minister Shinzo Abe’s stimulus policies wane. Sony Corp. (6758)’s declining revenue from phones and cameras and the exposure of trading companies such as Marubeni Corp. to China’s economic slowdown also pose risks.
“Japan will face more difficult conditions with worsening deficits” in both the trade and current account, Toshihiro Uomoto, the chief credit strategist in Tokyo at the brokerage, said in a telephone interview on March 18. “That will definitely change the whole financial market environment.”
A decline in the competitiveness of Japanese products and services is partly to blame for worsening data, which can’t be fully explained by rising import costs as the yen weakens, said Uomoto, who hasn’t advocated buying default protection for the past 18 months. Mounting trade deficits may erode Japan’s ability to finance the world’s largest debt load, which is forecast to equal 242 percent of economic output by the end of 2014, according to International Monetary Fund.
Japan’s finances are “already in a critical state” and look set to worsen, according to Uomoto, ranked as the country’s No. 1 credit analyst in a Nikkei newspaper survey in 2013. The nation’s credit markets face “general widening” in the next two to three years even if spreads tighten under pressure from monetary stimulus in the year from April, he said.
The yield premium that investors demand to hold Japanese company bonds was 24 basis points over government debt on March 19, the lowest level since August 2007 and compared with 119 for global corporates, Bank of America Merrill Lynch data show. The cost to insure against default a basket of 50 investment-grade Japanese companies was 78 basis points, 11 basis points above a 5 1/2 year low recorded in January, according to data provider CMA’s prices. A basis point is 0.01 percentage point.
“I don’t see spreads expanding rapidly due to some credit bubble collapse,” said Yoshihiro Nakatani, a Tokyo-based senior fund manager at Asahi Life Asset Management Co. Spreads will probably widen gradually this year as companies boost debt for investment, and bondholders demand higher premiums to hold less creditworthy companies, he said.
Standard & Poor’s remains cautious about the prospects for a “sustained solid recovery” in the creditworthiness of Japanese industrial companies this year, even as Abe’s policies provide support, it said in a report last week. The credit quality of the nation’s consumer electronic makers will stay under pressure, it said.
Companies including Panasonic Corp., Sony, and Sharp Corp. (6753) “continue to face rapid commoditization of products they offer and shifting demand,” S&P said in the report dated March 14. The manufacturers have a smaller global market share and less brand recognition than competitors such as Samsung Electronics Co. and Apple Inc., “and have even seen their domestic market shares shrink,” it said.
S&P cut Sony’s credit rating one level to BBB-, its lowest investment grade, on Feb. 14, and said it could lower the score further if the company’s earnings and profitability don’t recover and stabilize. Moody’s Investors Service reduced Sony’s rating to Ba1, its highest junk rating, in the previous month.
Marubeni, one of Japan’s largest trading companies, is sensitive to a decline in Chinese demand for commodities such as coal and copper, according to Uomoto, who is advising investors buy default swaps for it and rival Itochu Corp. Marubeni’s contracts are at 67.4 basis points, seven basis points from a six-year low, according to CMA prices.
“There are a lot of investment-grade bonds that are expensive,” said Nobumasa Mizutani, the chief investment adviser at Japan Credit Advisory Co., a hedge-fund advisory firm in Tokyo. It’s a time to use credit-default swaps to mitigate against volatility being caused by geopolitical and political problems, he said.
Uomoto recommends buying default protection on Kintetsu, an Osaka-based railway, because of Japan’s shrinking population and tough competition between local department stores, which the company operates. The bond risk of Sumitomo Realty, a developer in Tokyo, may rise as Abe runs out of stimulus options, he wrote in a report.
By contrast, Uomoto says SoftBank Corp.’s earnings outside Japan make it attractive as a credit investment. Billionaire Masayoshi Son bought Sprint Corp. of the U.S. last year and is trying to acquire T-Mobile US Inc.
Abe came to power in December 2012 advocating fiscal spending, deregulation and unlimited stimulus by the Bank of Japan to end deflation and fuel economic growth. The measures, known as Abenomics, helped reduce the benchmark 10-year yield to 0.605 percent today as the BOJ bought about 7 trillion yen ($68 billion) of sovereign notes a month. The yen has weakened about 15 percent since the end of 2012 to 102.43 per dollar as of 10:55 a.m. in Tokyo.
The effects of the stimulus may be fading.
Japan’s gross domestic product grew at a less-than-forecast 0.7 percent pace in the fourth quarter, before a 3 percentage-point increase in the sales tax in April that analysts expect will cause the economy to contract.
The nation recorded a 20th (JNTBAL) straight month of trade deficits in February, data from the finance ministry showed yesterday. The current-account shortfall reached a record 1.6 trillion yen in January, figures earlier this month showed. Japan has posted a surplus every year since 1981 in the broadest trade gauge, enabling it to become the world’s largest creditor.
Economists are split over how long Japan’s government has to rein in its debt, a Bloomberg News survey shows.
Eleven of 34 analysts said the government has four years or less to put fiscal policy on a sustainable path and avoid a crisis, while seven said it has over 10 years. BNP Paribas SA and Credit Suisse Group AG were among five saying it’s too late to avert one. UBS AG says chances of a fiscal crisis are remote.
“I am quite pessimistic,” said Nomura’s Uomoto. “I cannot tell from what incident the whole market will suddenly change but I think it will happen.”
To contact the reporter on this story: Finbarr Flynn in Tokyo at email@example.com