Diary of a Financier

On Japan: Land of the rising Sony

In Capital Markets on Thu 11 Apr 2013 at 22:25

I have some exposure to Japanese equities (~3% direct), which have been the top performer in global markets ytd. I’m poaching an entry point for more broad exposure via the Japanese FX Hedged Equity ETF (DXJ),¹ so I wanted to record my thoughts on the dynamics at play here.

My Top Newsstuffs have covered much of the key cogs that have helped Japan’s NIKKEI (NKY) blast ahead with 30% ytd gains, so I won’t delve into the politics & analysis of “Abenomics.” (A more quantitative macro/fundamental analysis of Japan can be found here.)  However, just to be clear, the whole Japan thesis relies on FX markets, specifically the devaluation of the Yen (JPY), which is something I do want to discuss herein.

JPYUSD is -22.3% peak-to-date. I compare that to DXJ +50.2% across the same period, and I’m not surprised to find such a high correlation (0.926) between these two:

DXJ v USDJPY daily- includes correlation

DXJ v USDJPY daily- includes rolling correlation

I am surprised to find such a high yield from devaluation; every -1% decline in JPY yields +2.25% in upside for Japanese equities. Obviously, I want to have high conviction regarding JPY before I undertake more Japanese equity exposure.

Earlier this week, I commented on USDJPY. I observed that the pair has been “Cup & Handle-ing” its way higher, bouncing down off every rim resistance along the way, before breaking out to the next check-point. With this priceaction in mind, the next rim resistance lay near USDJPY 101.50:

USDJPY daily/weekly/monthy

USDJPY daily/weekly/monthy

Given today’s spot USDJPY, that leaves an implied +4.1% upside in DXJ before a pullback. So, why don’t I buy here and now? The last two JPY pullbacks from rim resistance calculate to a -3.71% & -4.31% drawdown (peak-to-trough), and DXJ’s -5.15% & -8.04%, both lasting just about 2 weeks. That sets my base case at around +4% return vs -5-8% risk, a function that’s skewed to the downside. Further, given the steepness of this last rally’s pitch (DXJ +16% in only 6 days), I expect a commensurate snapback a la your elastic band.

~~~~

Transitioning now to Japanese singlenames, I’ve owned Sony (SNE) since February to gain high-leveraged exposure to this Japanese theme. SNE was trading at a P/B of 0.6 at the time of purchase (now 0.73) vs. a NIKKEI average of 1.2 and peers all >1.0.

Sony’s management had explicitly talked-down analysts’ excitement over Yen weakness, which has served to temper expectations so far this year. But, I’ve done the math: while USDJPY has little effect on SNE’s bottom line, every ±¥1 move in JPYEUR yields ¥6B in incremental net income. To put that into perspective, SNE projects ¥6.6T in FY12 revenue and only ¥20B in net income… and EURJPY has repeatedly jackknifed lower -¥16.07 ytd (-12.4%),² which translates to ~¥97.42B in incremental net income (ignoring convexity).

~~~~

In summary, I will hold SNE through the bumps that may lay ahead–and bumps certainly remain–until fair value is realized. I’ll use the broad Japanese index exposure for more tactical maneuvering. Right now, I don’t need to engage such a tactical trade as DXJ, thus I certainly won’t until I get a pullback from this latest parabolic spike.

–Romeo

¹The currency-hedged feature of DXJ (+28% ytd) is important, since a lot of return gets lost in FX conversion when you have a depreciation episode like this (unhedged EWJ +16% ytd).

²When quantifying JPY depreciation/appreciation, JPY should be the base currency in a pair (e.g. JPYEUR), which is how I calculated the percentage depreciation cited here; when I quoted the ¥ value drop relative to EUR, however, I had to have JPY as the quote currency (e.g. EURJPY).

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  1. Started by buying small position (1/2 sized)…

  2. […] which we built throughout the June pullback.  Sony ($SNE) is one of our largest singlename equity holdings, so I’m evaluating whether or not to trim the position (+50% gains) for idiosyncratic […]

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