Strong Yen is Bad News for Japan Stocks

• The financial market commentary recently sounds more like a commercial for Baskin Robbins, i.e.,  “ double dip!, double dip!”, and equity indices are now fighting historical odds in being able to show positive returns for 2010, while bond returns are outperforming stock gains by the widest margin in nine years as investors scramble to preserve capital from a double dip recession. In our view, however, the risk of a significant selloff from here is limited, despite further growing evidence of a slowdown. 
  
• What businesses and investors dislike most about the Euro sovereign issue, China’s tightening, the talk of a double dip, etc. is uncertainty. Take away the uncertainty, and stock prices react positively. A good example is British Petroleum (BP); cap the well, cap the uncertainty, and the stock soars. Another example is Goldman Sachs (GS).
• Since China’s Shanghai Composite has taken the biggest hit this year (down 24% YTD), it could be an interesting contrarian play for the next 6‾12 months given the high growth potential China continues to offer. Since China is so important to the supply-demand balance for commodities like crude oil and copper, rallies here are also keyed to what happens with China stocks. Meanwhile, other Asian economies are doing quite well, thank you as are their stock markets, so much so that to a man they are having to tighten monetary policy to get ahead of inflationary tendencies.
  
• On the other hand, while Japan’s Nikkei 225 has declined less than other major markets in 2010, this is merely because it lagged the 2009 equity rally so severely. Declining JGB yields are pointing to downside risk in Japanese stocks. The IMF has warned Japan that it needs to get its fiscal house in order. So what? It’s not as if Japan’s politicians don’t know this, it is a question of being able to execute. The DPJ and Naoto Kan tried to make good on their promise to the world that they would get their fiscal house in order, but look what happened. They were handed a sound thrashing in the upper house elections that is discouraging further talk of austerity, even though everyone, even voters, is very aware that Japan needs to come to terms with its mountain of government debt.
  

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