4 Important Bearish Facts You Must Know About Japan

Japan was back in the news late last week as yet another earthquake hit the country in approximately the same region as the big one in March.  This one was far smaller and apparently did much less damage; however, the Nikkei and global currency markets reacted strongly to the event, falling precipitously as the news came out and then rebounding sharply on Friday as damage was less severe than expected.

Investors and traders in the Japanese (NYSE:EWJ) sector have been on a wild ride lately and certainly this can be expected to continue as aftershocks, political, psychological and economic, continue to hit.

As I look at this market, I prefer not to speculate but take a longer term view, and what I see is that, long term, recent events cannot be good for this powerful island nation, the third largest economy in the world, or for its trading partners including the United States.

Here are the bearish facts:

1. The world’s third largest economy will likely suffer a setback in GDP.  They were barely staying above flat line before this shock, and now with hits to their fishing industry, cutbacks in auto production and whole towns disappearing, perhaps never to be rebuilt, it’s hard to make a robust case for growth even when one factors in a boost in construction spending from rebuilding.

2. Recently a ship from Japan was turned away by China and the first ships to arrive in Europe since the earthquake and tsunami are being inspected for radiation in Antwerp and Rotterdam this week.  The outcome of these first arrivals will be very important as Japan moves about 4% of the world’s containers and is a major shipping nation with some 20% of total shipping traffic calling on their ports.  Any kind of hitch here would put a severe kink into global shipping and the global supply chain.

3. Nissan, Toyota (NYSE:TM) and Honda (NYSE:HMC) have cut back domestic, European and American production due to parts shortages and power shortages, which likely have a significant negative effect on the economic outlook for the auto industry through at least the end of this year.

4.  Japan, already a highly indebted nation, will have to take on more debt to recover from this crisis.  Japan’s debt is 230% of GDP and recovery from this earthquake will cost billions.  Furthermore, the thing that has saved Japan so far, the fact that their debt has been largely internally financed by the savings of its citizens, could be about to change in a big way.  Much of Japan’s debt is held internally, unlike the United States and other infamous debtor nations, but that is about to change as their aging population shifts from saving for retirement to spending in retirement.  Beyond that, if interest rates were to rise even fractionally, which they likely will, interest payments alone would eat up a huge portion of government revenue, making it more difficult to pull out of the quagmire in which they find themselves.

Just after the earthquake, I wrote, “My take on this subject is that the overall outcome for Japan and the global economy will be more substantial and long lasting than many expect.  If it was just a “normal” natural disaster, I would subscribe to the expectation of a short term hit followed by a V shaped recovery.  However, this situation has more elements that need to be considered.  First, Japan has an aging population and is in a long term deflationary environment that will almost certainly be aggravated by this situation.  Demand will decline by some as yet unknown amount and the country will add to their already significant debt load which can’t in long run be good for the Yen or their overall economic output.”

Now nearly a month after the initial disaster, I believe that the outlook is still a bearish one, even without considering the fact that global energy prices are spiking higher and the country will have to import greater percentages of their power needs which puts them in an even more difficult position.

If you’re bearish on Japan, you could take a look at EWV (NYSE:EWV), the ProShares UltraShort Japan Index for potential opportunities.

Chart courtesy of Stockcharts.com

A quick glance at the chart shows the turbulent nature of this market and this action is likely to continue for sometime.

Another bearish play in Japan is to “short” the yen with YCS (NYSE:YCS), the ProChares UltraShort Yen ETF.

Chart courtesy of Stockcharts.com

YCS is also a 2X inverse ETF and so offers leveraged exposure to the Yen and a profit opportunity if the Yen should decline.

Overall, I can’t see a happy outcome for Japan going forward as the country was barely making it in terms of economic growth before recent events.  Ongoing shocks like Thursday’s earthquakes, an aging population coupled with huge debt load and an as yet to be determined injury to its industrial plant leaves the economy in a vulnerable and dangerous position.

Wading into these waters will require skill and adroitness for those who decide to play, but those on the winning side can profit mightily as global events like these tend to offer generational opportunities.

Disclosure: Current portfolio holdings include positions in inverse exchange traded funds, gold and oil.

John Nyaradi is the author of Super Sectors: How To Outsmart the Markets Using Sector Rotation and ETFs.

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