“Japan Passing” and The impoverishment of Japan    

• Japan's market seems to be lagging further and further behind the global equity rally, hampered by, a) a soaring yen, b) concerns that zombie financing is back in Japan and c) the risk of an eventual nasty outcome (i.e., yen melt-up) if current secular trends cannot be turned.  
• The yen is already at a 14 year high, and the data show that Japan's real GDP is in worse shape than in 1995 (in the midst of the Heisei Malaise) when the yen was last at JPY80/USD. The aging of Japan's population has progressed rapidly, bringing with it a dramatic decline in the savings ratio and persistent deflation. Meanwhile, Japan's net debt/GDP ratio has soared, from only 24.1% in 1995 to nearly 100%.
• Basically, the return to zombie financing in Japan will only accelerate the impoverishment of Japan already underway as a mountain of debt chokes off economic growth. As debt-ridden zombies don’t pay taxes, saving them will do nothing to redress a serious shortage of tax revenues amidst record fiscal expenditures. Moreover, it chokes off the emergence of more dynamic, competitive companies that would ostensibly improve productivity.
• As a result, the national poverty rate as measured by the Health and Welfare ministry, which  stood at 15.7% percent in 2006, is undoubtedly noticeably higher now. Japan already has the fourth-highest rate of relative poverty among OECD member countries.
• While we are far from wild-eyed bears on Japan, the long-term implications of current secular trends are fairly clear, i.e., JGB yields, now at historical lows, could go much, much higher, the yen may not be finished appreciating, and there is still a risk of a double dip in Japan’s recovery. Given these factors, we see more Japan passing and a general underweight of Japanese equities, even though Japan's economy and stocks will continue to ride the coattails of the global economic and equity market recovery.
• Given the high probability of more large capital calls, we are particularly cautious on the megabanks, and would currently choose any South Korean major over its Japanese peer in the consumer electronics sector as well as automobiles.

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