Japan, Life Insurance Companies and Bedroom Talk…

It must be the stench of an enormous pile of debt that keeps bringing me back to Japan. Like a scavenging mongrel at a rubbish dump, I’m drawn to the pure absurdity that exists in today’s financial markets. Greece, Italy, Ireland, France they’re all running unsustainable finances. The problem is that the markets have for the most part figured this out. A beneficial risk/reward setup for a trade on their debt simply doesn’t exist any longer. Not so with Japan… which I believe spells opportunity.

My bedtime reading typically amounts to a smattering of parenting books, heavily seasoned with some on history, and financial history in particular. Not riveting bedroom talk my wife tells me (she accepts my enthusiasm but doesn’t share it) so instead, you dear reader, suffer. One has to pursue one’s passions somewhere no?

History is perpetually being written. Right now we are smack dab in the middle of a breakdown in the world’s monetary system as we have known it. The various steps down this particular path have been many. I won’t insult your intelligence with detailing them here since they are all clearly evident to anyone paying it even a modicum of attention. What I’m concerned with is finding anomalies in markets that have not been accurately priced by the collective market.

Betting on an inevitable and overlooked crisis in the fiscal situation that Japan finds itself in is one such anomaly. This miss-pricing of risk has led me to investigating various means of profiting from the results of decades of deflation, which have induced coma-like buying of Japanese government debt by a citizenry who have become accustomed to a single asset class outperforming all others. What asset class? JGB’s. I suspect that we are nearing an end to this coma. Some could call it a collapse, but I like to be a positive guy so I’m going to call it an “awakening”. It has a much nicer ring to it.

These bond buyers have continued to trudge up to the trough for more government debt, while that same government’s debt burden has blown out to stratospheric levels.

What do you know about this stuff Chris? You’re not an economist. To which I say, “What makes you think economists know anything about this stuff?” Central bankers have been inducted into “economics” with a near religious belief in Keynesian-ism. See how that’s working out? Take a look at the world. I rest my case.

Back to Japan though. I look at a government who spends over 50% of their central government revenues on interest payments alone (while interest rates are about as low as they can possibly go) and my non-economist brain instructively tells me “bad juju Chris.”

Economists, unlike money managers and investors such as Mark and I, don’t have to worry about their own personal balance sheets or income statements, they instead get paid to pontificate on broken mumbo jumbo theories.  I’d probably take the gig if I could somehow get over the obvious moral issues, and if someone was stupid enough to pay me large amounts to talk codswallop. I’d get to dictate fatally-flawed theories and let others test them with their money. Iceland… Oops that one didn’t work to well did it? OK, next theory… Greece, Italy – we’d be better of consulting my cat, and she is easily one of the stupidest, laziest animals I’ve ever come across.

Some options… literally…

Short FXY. The option chain goes out just over 12 months. Not optimal, and volume is low. Specifically, out of the money puts are relatively cheap. I’d just keep a small position and keep rolling further out as time decays. Once we get a move in the yield then I’d be hitting the accelerator for the meat of the trade.

Spread bet the JGB market through one of the spread betting companies such as IG Index. Not sure of the particulars of this for US citizens, as these guys run out of the UK. You get to choose your leverage.

Short domestic life insurance companies and Pension funds. A large portion of their assets are in government debt instruments. A wipe out in JGB’s would in itself likely bankrupt many of these insurers. Even if somehow, unbeknownst to me, the JGB market holds up for the next decade, demographics alone will cause these companies to see declines in capital inflows and redemptions in order to finance living expenses.

I don’t know how anyone can be long these companies. Since I haven’t had the time to begin perusing the balance sheets I offer a prize to any reader who can identify the shittiest balance sheet in this sector, loaded with JGB’s.

The prize

You’ll have done the research yourself and feel much more confident than you will ever feel by simply listening to Mark and I. What’s that worth? I’d say it all depends on how much you put into the trade and how well you manage that trade. As I mentioned before in 3-life changing lessons, you’ve got to learn to do the quantitative analysis, trust yourself and pull the trigger. When you nail it the feeling is magical. Trust me it is one of the best prizes you will ever receive… period!

I have some other ideas on this front but they will have to wait for another day. I still need to wrap Santa’s presents for two little children and go get some bedroom talk in with my gorgeous wife!

Wishing you all a fantastic holiday time, hopefully spent with those you love.

- Chris and Mark

“Christmas is a time when kids tell Santa what they want and adults pay for it. Deficits are when adults tell the government what they want and their kids pay for it.” - Richard Lamm

Comments

  1. I’ve just posted this under your previous entry on shorting JGBs – timely!
    ————-

    Festive Greetings!

    Hopefully you guys will still see comments on this post…

    I’ve just come across the PowerShares 3x Inverse Japanese Government Bond Futures ETN (ticker: JGBD). It listed mid-November this year. It provides investors with: 3x notional exposure to the 10-year JGB future + exposure to 3m T-Bill index – fees, converted into USD from JPY.

    Clearly it has drawbacks:
    • It’s sponsored by Deutsche Bank’s London branch, making investors senior unsecured creditors to a subsidiary of a wobbly Euro bank
    • The 3x returns won’t be achieved over the long term due to monthly resets and fees
    • There is some exposure to US 3m T-Bills
    • Deutsche Bank can call the securities at any time (albeit at a prescribed market value)

    Nonetheless, it could be an interesting way to get exposure to a short of long dated JGBs.

    Do you have an opinion on it?

    Thanks

    Fact sheet: http://www.powersharesetns.com/ps/pdf/P-DBSJG-ETN-PC-1.pdf

    Prospectus: http://www.powersharesetns.com/ps/pdf/P-DBSJG-ETN-PRO-1.pdf

  2. Thanks for that Matthew

    Typically I dislike leveraged ETF’s. Volatility and the rolling of contracts eats into your capital position even where the overall trend may be in your favour. I think they’re better suited to short term trading.

    I need something with a decent time frame (5 years would be optimal in my opinion) on it, yet providing sufficient leverage to provide me with multiples on my capital. A CDS for someone who doesn’t have hundreds of millions of dollars essentially.

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