China Taps the Brakes: Japan Looking for the Accelerator     

• The steep yield curve, falling bond spreads, the S&P 500 VIX and lower rated as well as emerging bond prices all collaborate what the investor surveys show, i.e., that investor confidence is back to pre-crisis levels two years ago. More economists are suggesting the US economy could see 5%~6% PA growth. At some point, this could cause a temporary "inflation scare" with traders discounting Fed rate hikes long before the Fed is ready to actually move.
• In China, massive government stimulus early in the crisis has produced the desired result, i.e., China's growth is back above two-digits versus initial forecasts of growth more like 5%~6% PA. However, massive loan growth to supercharge domestic demand and offset the drop-off in imports needs to be contained for China to fend off re-emerging bubbles. Thus China is now "tapping on the brakes" to reign in this speculation. Unlike the past, we don't see China slamming on the brakes so hard it throws all the passengers through the windshield.
• Concern about US and China central bank course changes could well trigger an interim correction in both markets, but we believe these corrections will not be serious i.e., not cause a resumption of the "old" bear market.
• Meanwhile, Japan is still trying to find the accelerator. The developing DJP political funding scandal could actually make the yen incrementally weaker if it threatens to delay legislation on supplementary budgets aimed at ensuring no double dip in Japan's economy.  The 10% or so reversal in JPY/USD has already ingnited a 20%-plus rally in the Nikkei 225, driving outperformance for December and so far this month. As long as JPY remains weak or benign, the Nikkei 225 rally can continue.
• This rally is also being driven by foreign investors, who have piled back into Japanese equities to the tune of a net JPY2.75 trillion since the last week of November 2008 from extremely underweight positions.

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