Japan and China: mad investments make sense for locals

Nov 18, 2009, 11:18

Cris Sholto Heaton

Posted byCris Sholto Heaton

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What do the booming Chinese property market and the staid world of Japanese government bonds (JGBs) have in common? Perhaps more than you'd think.

In this week's MoneyWeek Asia, I looked at Chinese property. Put briefly, I concluded that local investors buying apartments to keep them unoccupied in the hope of selling them at a higher price in a few years time may not be as daft as it looks, given the limited choices they have for alternative investments.

Now, if that sounds like the dangerous 'it's different this time' argument, I applaud your cynicism. But it's worth noting that this isn't the only situation where domestic investors are semi-rationally doing things that would be irrational for foreigners.

Take JGBs. Despite Japan having gross public debt of 180% of GDP, the yield on the ten-year JGB stands at 1.315% a year. How can the government get away with this? Because 95% of the bonds are held by domestic investors.

In a deflationary environment where interest rates are zero, businesses have spent two decades paying down debt, banks didn't want to lend, and the stockmarket has been hitting new lows since 1989, there have been enough institutions willing to accept tiny but certain returns like these. That's despite them being able to put their money anywhere in the world - unlike the average Chinese investor.

But while this may be sane(ish) for locals, it's clearly not the best choice for people with more options. So foreigners should be as wary of buying a property in China as most would be of buying JGBs.

What's more, neither trend is sustainable in the long term, even if it makes sense now. Japan must fix its finances or face a blow-out in borrowing costs. And the more new Chinese apartments that get built and sold, the less the current stock will be worth.

The question in both cases is: will investors spot the tipping point and stop buying in time?

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  • 1. Tom F

    (19 November 2009, 07:29PM)  Complain about this comment

    Marc Faber believes that Japanese stocks are a good purchase because any sign of real increased inflation then the Japanese will flood their mone out of Japanese bonds and into their stock market.

    Huge fan of your writing Cris. Coupe of comments -

    Can you please write up more about Asian Investment Trusts?

    ITs are by far the best place for long term investors to be IMO.

    Could you please comment on the relevant strengths and weaknesses of each.

    Also, most Asian investments seem to be priced in dollars. Could you comment further on more sterling currency investments in Asia.

    Not sure any of us wants to be long the dollar!

    Many thanks for the great posts.

  • 2. Alan Hanson

    (20 November 2009, 12:04PM)  Complain about this comment

    "Marc Faber believes that Japanese stocks are a good purchase because any sign of real increased inflation then the Japanese will flood their mone out of Japanese bonds and into their stock market."

    The only problem with this theory is that JCB prices would collapse and yields on future JCB's would rocket. Where does that leave a country with borrowing at 200% of GDP - unable to fund the interest.

    The way the USA and UK are going with QE and lunatic spending we might all find out the hard way.

  • 3. Cris Sholto Heaton

    (23 November 2009, 02:12PM)  Complain about this comment

    Thanks Tom. Yes, I usually prefer investment trusts to other funds as well. I’m trying to put together a comprehensive list of Asia investment trusts/closed-end funds at the moment and once it’s done (it’s a slow job), I’ll do a feature on them. Will look at USD too.

    Japan – yes, I’d agree on both points. Equities look the best option if inflation comes back in Japan (small-caps are interesting – cheap and lots of potential restructuring). But the debt costs are a big problem.

    The only thing in Japan’s favour is that the most of the debt matures a few years out and the level of index-linked and variable-rate debt is low (unlike UK). So if inflation were to tick up gradually and they kept rolling the debt over to long maturities, the bond market might not notice in time.

    I don’t know what the endgame is for Japanese debt. Inflation? Severe spending cuts? Huge asset sales? Monetisation? Default/restructing? But I think the odds are against it being good for JGBs.

  • 4. John Aislabie

    (03 December 2009, 07:50AM)  Complain about this comment

    Japan’s extreme distrust of foreign markets partly reflects the very low level of respect for their own. The sense is that the Japanese market is working to unseen forces known only to insiders and much of this is not wrong Also many Japanese companies, largely protected from shareholders by absurd voting, poison pills and massive cross shareholdings, have got used to making ludicrously small returns on assets invested and are wholly unable (as well as aggressively unwilling)to address the kind of questions that a picky investor would want to have answered. These companies concentrate their entire energy on sales and world market share, the returns to investors don't really enter their top ten thoughts. In the almost twenty years since it became clear that the banks could no longer play endless sugar daddy, funding companies that treated shareholders abominally the yen still hasn't dropped that the companies need to concentrate on a return, if they are to attract expansion finance.

  • 5. John Aislabie

    (03 December 2009, 07:50AM)  Complain about this comment

    Japan’s extreme distrust of foreign markets partly reflects the very low level of respect for their own. The sense is that the Japanese market is working to unseen forces known only to insiders and much of this is not wrong Also many Japanese companies, largely protected from shareholders by absurd voting, poison pills and massive cross shareholdings, have got used to making ludicrously small returns on assets invested and are wholly unable (as well as aggressively unwilling)to address the kind of questions that a picky investor would want to have answered. These companies concentrate their entire energy on sales and world market share, the returns to investors don't really enter their top ten thoughts. In the almost twenty years since it became clear that the banks could no longer play endless sugar daddy, funding companies that treated shareholders abominally the yen still hasn't dropped that the companies need to concentrate on a return, if they are to attract expansion finance.

  • 6. John Aislabie

    (03 December 2009, 08:12AM)  Complain about this comment

    Apologies for a double post and for "abominally"..abominably of course

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