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Which Comes First?
Japan Revival or Fiscal Crisis?

The Mother of All Bear Markets
• Japan's stock market has been in a bear market for 23 years, since peaking in December 1989.
• The Nikkei 225 is still trading some 78% below the 38,916 peak, or since the bursting of the
property and stock market "bubble".
• JPY/USD has doubled in value since then, seriously eroding the competitiveness of Japan's
export machine and decreasing the value of overseas sales.
• Basically, Japan's nominal GDP has flat-lined since the mid-1990s, and given ongoing deflation,
real GDP "growth" is meaningless to all in Japan but the economists.
• This after hundreds of trillions of fiscal stimulus and near-zero interest rates since the Bank of
Japan first introduced quantitative easing in 2001.
• The only visible result of this massive fiscal and monetary stimulus is massive public debt,
which credit rating agency Fitch says will be an eye-watering 239% (gross) by end 2012.
• The flip side of the bear market in equities has been a two-decade long bull market in bonds,
called JGBs in Japan.

Nikkei 225 Monthly
Only One Rally to Speak of (2003~2007) in 23 Years

Source: Yahoo.com

10-Year JGB Yields
A 22-Year Bull Market

Sources: Bank of Japan, dshort.com

JPY/USD Monthly Exchange Rate
A 42-Year Bull Market

Horrible Demographics
Shrinkage in the Labor Force is Even More Dramatic

Sources: Health, Nutrition and Population statistics (HNP), World Bank.

Shrinking Nominal GDPNominal GDP Back to 1993 Levels

Source: ESRI, Econompic

The Debt Trap
Why Japan's Economy Cannot Grow: Lessons for the U.S.

Sources: BIS, Matthews, SeeTell

Borrowing to Spend More
Government Has to Borrow More than its Revenue

Japan's Debt Dynamics
A Bug In Search of a Windshield

The Endgame: Possible Ways Out
Endgame Could be Only Several Years Away.

• Grow revenues (GDP growth): hindered by growth-choking debt.
• Austerity: VAT hikes, entitlement cuts, etc. only of marginal help, and could
exacerbate government deficits.
• Economic Reforms: tried by Koizumi Administrations with some success,
but now discredited. No political will or commitment.
• Massive BOJ money printing: Most likely scenario = structural JPY
weakness, improved export competitiveness, but deteriorating balance of
payments. Temporary spike in JGB yields triggers bank, pension fund
losses.
• De-Facto Internal Default: Repudiation, financial repression.
• Overt Default: Very unlikely, but JPY could plunge to JPY400/USD.

Current Stock Valuations are Cheap
How Much of the Bear's End Game is Already Discounted?

• The 1,671 companies in the Topix Index have some 105.2 trillion yen
($1.34 trillion), or 41%of their market value in cash.
• The whole Topix, TSE Second Section, and Nikkei 225 trade under stated
book value.
• The Nikkei 225 is trading on 11X forward earnings, with an 8.8% earnings
yield and 8.2% ROE. Dividend yield is 2.3% and complemented by
shareholder perks as well as 217 companies announcing share buybacks
in 2012. This compares to 2.1% for U.S. firms.
• Almost half of Topix companies have more cash than debt, the highest
percentage of any developed-country index, according to Bloomberg data.

Nikkei Again Selling for Less than Book

Source: Nikkei Astra

Catalysts
Cheap Valuations are a Mere Value Trap Without Catalysts for Change

• Investors will react positively to any indications BOJ is moving to
aggressively print money, as was seen in November 2011 and February
2012. (most probable)
• The only real rally in the 23-year bear market was the Koizumi revolution,
i.e., a government committed to full-scale, far-reaching reforms. (least
probable)
• A secular rise in US treasury yields that results in a significant widening of
the U.S.-Japan rate gap, thereby creating signficant JPY weakness beyond
JPY120/USD. (not likely in the short-term)

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Japan Overview

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Japan Overview