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Posted 8/15/2005
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Japanese showdown might cost you big
If Japan's prime minister wins re-election, expect a stronger economy there and a stronger yen. That translates to trouble for the dollar and our speculation-based housing and stock markets.
By Bill Fleckenstein
There has been an unmistakable shift in the macro winds. The potential toll on U.S. assets is the subject of this week's column.
I'll begin with the changes afoot in Japan, then look at their possible negative impact here in America. Last week, Prime Minister Junichiro Koizumi may have lost the vote to privatize the country's postal system. But he fought back, calling for elections on Sept. 11.
Japan's big problem has been that, while nominally capitalistic, it's really a centrally planned economy, thanks to the policies and power of the ossified Liberal Democratic Party. I believe that if Koizumi is re-elected, that may unleash a far more capitalistic system in Japan than what has prevailed thus far.
A more efficient and stronger economy would be bullish for Japan's stock market and the yen -- both from an economic standpoint and because the Bank of Japan might stop trying to suppress the yen's value. Oil would be cheaper in Japan if the bank let the yen rally, and, since the country is a "middleman" exporter of many goods, a higher yen wouldn't necessarily hurt its economy. (Editor's note: The yen has risen 2% against the dollar but is down more than 6% so far in 2005.)
To repeat, I believe that these developments are bullish for the Japanese economy, the Japanese stock market and Japanese currency. However, they are probably bearish for Japanese government bonds. The yield of about 1.5% on Japan's 10-year bond is the dumbest interest rate on the planet. I think that yield is almost guaranteed to go higher if I'm even half right about what's transpiring in Japan.
Now, I realize that I've just assumed a great deal. But I believe that even if all these ramifications don't come to fruition, the markets may begin to "trade" these ideas.
Related news and commentary on MSN Money
Japanese gain and real-estate pain
Most importantly -- and getting back to why this all matters here -- a stronger yen (i.e., a weaker dollar) would undermine demand for U.S. Treasurys. In addition, demand would be undermined if yields on Japan's bonds rose. All things being equal, those developments ought to lead to higher interest rates here -- further pressuring our real-estate market.
To get a feeling for the budding inventory problem in many previously hot markets, let's look at a less-hot market (via the following vignette from a reader of this column): A publicly held home-building company (which shall remain nameless) in Columbus, Ohio, has been buying back homes from financially distressed owners and reselling them, at reduced prices, only to folks who are approved for conventional mortgages. As the reader says: "The inventory of homes is growing -- including one cul-de-sac where a staggering 13 of 20 homes, all less than three years old, are already up for sale."
Mini-primer on subprime problems
Up until very recently, finance companies were able to come up with more and more imaginative products and expand the pool of potential speculators in the real-estate market -- thereby making it possible for prices to hold steady or be driven higher.
But a contact in the subprime-lending arena (lenders who specialize in making loans to borrowers with less-than-stellar credit records) suggests to me that it's becoming increasingly difficult for originators of subprime mortgages to sell them at a profit. Unless all of these are booked on the originator's own balance sheet, we'll start to see credit being cut off to the more marginal real-estate speculators -- the driving force, at the margin, behind the real-estate market.
Meanwhile, subprime-mortgage company New Century Financial (NEW, news, msgs) recently lowered its earnings projections, even though its loan volume is supposed to be rising. What that means, among other things, is that the company is facing margin pressure, which jibes with my contact's information. (I added to my New Century short position last Wednesday. I'm trying to be alert to additional problems, as it's beginning to feel to me like the short side of the entire housing ATM is slowly becoming an investible idea, not that I've done much about it just yet.)
Cold shower for a hot market
In any case, I believe what's now changed is that, with the advent of problems in the subprime arena, the pool of potential buyers will begin to shrink. That will be a very big development, as it is a significant change at the margin. All important change tends to begin at the margin, and I think this is a perfect example.
Thus, the macro winds have shifted, I believe, and none of those shifts has occurred in a way that is bullish for U.S. assets. Bottom line: It's my opinion that a top is being formed (or is already in place), both in the housing market and the stock market. That spells trouble for an economy built on the unsustainable strategy of trying to speculate our way to prosperity.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money. At the time of publication, Bill Fleckenstein was short New Century Financial.
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