CLSA Sees Bond Danger in Pension Switch to Stocks: Japan CreditFinbarr Flynn and Tesun Oh
CLSA Asia-Pacific Markets said investors should take cues from Japanese Prime Minister Shinzo Abe’s urgency to have pension funds trim bond holdings, as relative valuations swing in favor of equities.
“The danger that bond prices drop from here is very, very real so you need to get out of those things while you’ve got a chance,” said Nicholas Smith, a Tokyo-based strategist at CLSA. “The government is saying run don’t walk.”
Abe requested in June that the Government Pension Investment Fund, the world’s largest pool of pension assets, bring forward steps to alter the allocation of its 126.6 trillion yen ($1.22 trillion), 55 percent of which was in domestic bonds on March 31. Japan’s 10-year debt yield was 0.51 percent, or 1.16 percentage points below the estimated dividend yield for the Nikkei 225 Stock Average on Aug. 25 and the gap was the widest in 16 months two weeks earlier.
Unprecedented Bank of Japan buying of sovereign notes offers investors a window to sell the debt and move into other investments such as domestic shares, which are “stupid cheap,” said Smith. The Topix index has declined 1.3 percent this year after soaring 51 percent in 2013 as equity investors become impatient to see structural reforms promised by Abe.
The price-earnings ratio of shares on the Topix index was 15.6 times, compared with about 18 times for the Standard & Poor’s 500 Index, and 20.5 times for the STOXX Europe 600 Index, according to data compiled by Bloomberg.
Domestic ownership of JGBs has increased to 91.6 percent at the end of March from 91.4 percent in December 2012, when Abe took office, according to BOJ data. By contrast, Japanese financial institutions and individuals were net sellers of domestic stocks in the year to March 31, while overseas buyers boosted holdings of equities on Japanese bourses to a record 30.8 percent, Tokyo Stock Exchange data show.
“Japan has increased its exposure to bonds and sold the equity to the foreigner,” in contrast to Kuroda’s prediction that local investors will shift from debt to riskier assets, according to Smith. He has been in Japan since 1987 and joined CLSA in August 2011 after working with Jardine Fleming Securities in the 1990’s and a four-year stint at hedge funds, according to biographical information provided by CLSA.
The gap between Japan’s dividend and bond yields is 10 basis points from the widest since April 2013, reached on Aug. 8. In the U.S., 10-year Treasuries have a 0.42 percentage point yield premium over equity dividend yields as the Dow Jones Industrial Average climbs for a sixth straight year.
All 10 fund managers, strategists and economists in a Bloomberg News survey expect GPIF to trim its holdings of domestic debt, with six projecting a cut to 40 percent from 55 percent at the end of March. The fund will boost its Japanese stocks target to 20 percent from 16 percent, according to the median estimate.
“Japan’s finances are in a very severe state so unless drastic action is taken in the medium- to long-term, it will be a very dangerous situation,” said Fumio Nakakubo, chief investment officer for Japan at UBS AG’s Wealth Management division, at a seminar in Tokyo today. “For the time being, it is unlikely that Japan will default,” said Nakakubo, who cited the high level of assets owned by the Japanese government, domestic bond ownership levels, and potential avenues for raising additional taxes in a crisis.
The BOJ is trying to drive up property prices in Japan so that banks can lend against property and get the economy going again, according to Smith. Japanese lenders increased total loans 4.3 percent in the year ended March 31 to 499.3 trillion yen, according to the the Japanese Bankers Association.
Land prices in Japan’s three largest metropolitan areas gained for the first time in six years. The value of land in Tokyo, Osaka and Nagoya was on average 0.7 percent higher as of Jan. 1 from 12 months earlier, compared with a 0.6 percent decline in the previous year, the Ministry of Land, Infrastructure and Transport said in March.
Japan’s poor economic fundamentals, in addition to the BOJ’s buying of about 7 trillion yen of sovereign notes a month, are supporting debt prices, according to Tadashi Matsukawa, head of fixed-income investment at PineBridge Investments Japan Co. in Tokyo.
The nation’s economy shrank an annualized 6.8 percent in the three months through June, the sharpest contraction since the first quarter of 2011, after the government raised the sales tax in April to 8 percent from 5 percent. A Nikkei survey published this week showed that 63 percent of the public oppose raising the levy to 10 percent next year as planned.
“Japanese institutional investors such as banks and insurance companies have no real avenue for escape,” said Takafumi Yamawaki, chief rates strategist at JPMorgan Chase & Co in Tokyo. “The level of risk that they can take is limited so they won’t make large portfolio changes.”
The 10-year Japanese bond yield is forecast to climb to 0.9 percent by the fourth quarter of next year, according to analysts surveyed by Bloomberg. The yen fell 18 percent against the dollar last year in the wake of the BOJ’s stimulus, while it has strengthened 1.4 percent so far in 2014 to 103.89 as of 4:21 p.m. in Tokyo.
Japan’s sovereign-bond risk is at 38 basis points, near the lowest since 2008 of 34.5 touched on June 19, according to credit-default swap prices from data provider CMA. One basis point is 0.01 percentage point.
“While the 10-year JGB may be expensive, that is not to say that we’re going to see the bursting of some kind of credit bubble, and prices diving from here soon,” said PineBridge’s Matsukawa. “Japan’s economy is performing poorly.”