Zugzwang describes a dilemma when any move you make puts you in a weaker position. It’s a German word but the idea is taken from the game of chess.
In chess, there’s no random element. There are eight ranks and eight files with pieces that obey fixed laws. Not so in markets today, where central bank intervention is so heavy we doubt any one price is where it should be.
Investors probably feel a whole lotta zugzwang right now. If you can’t trust any price signals, which asset do you trust? Doesn’t any move feel like you’re opening up a weak flank?
This is especially true for the country that dominated discussion in our Albert Park headquarters this week: Japan.
So it’s the task of today’s Money Weekend is to explore what it means for Aussie investors….
It’s All About Japan
In case you’ve missed it, the Japanese stock market has been on a tear for about six months.
It’s up around 75% in a year – that’s a pretty astounding run for a major index. This has all been under the watch of Shinzo Abe in his second innings as Japan’s PM. Check him out below.
Can you imagine it? All Abe has really done is stick a puppet in the central bank and told him to run the printing press to the tune of $75 billion every month.
Hence the Japanese yen has collapsed 25% against the US dollar.
Granted, one argument for this is it might help Japan’s struggling exporters. As far as we can tell all it’s done is drive up the cost of Japan’s essential imports. You know, things like food and fuel.
Check this out from the Financial Times:
‘Japan’s trade deficit widened in April as the boost to exporters from a weaker yen was outweighed by rising prices for imports. Preliminary figures from the finance ministry on Wednesday showed that Japan posted a deficit of Y879bn ($8.6bn) in its trade balance last month, almost 70 per cent wider than a year earlier, as rising shipments of cars and iron and steel products were offset by much higher bills for fuel, food, clothing and semiconductors.’
That’s a real bummer for your average salaryman in Tokyo. Net result of currency depreciation: a rising cost of living and lower quality of life.
But, as mentioned, one thing the Japanese money printing has done is light the fire under the Japanese stock market, as you can see in the chart below (the black line) alongside the Australian market (red line).
This matters for Australian investors because both stock markets are moving so close together. A chart like this backs up Kris Sayce’s argument over at ASI that the fundamentals under stocks (the economy, earnings) matter less than the ‘torrent’ of central bank money flooding into the market and driving up asset prices.
You’ll notice on the chart that the Japanese stock market dropped like a stone on Thursday. It was a pretty savage break. In the end it was 7.5% down. Murray Dawes over at Slipstream Trader says he’s never seen a market move like that on the day.
But does this signal anything more than a correction?
We don’t know.
If you asked Murray he’d suggest the Japanese markets – currency, stock and bond – are the three most important markets to watch right now. They also happen to be some of the biggest in the world.
That’s why Murray expects Japanese fireworks to play out in Australia fairly soon. He sees the risk to the downside. But traders like him have the flexibility to move in and out, both long and short, taking advantage of the volatility .
Mispriced Market Mayhem
The orthodox bear position would be to say the central bank has inflated Japanese stocks. But you could say that about American stocks too, and they’ve rallied and held up since 2009. Why can’t Japan’s stock market motor along for a similar period of time? Who knows how long all this can go on?
Fiscally, Japan is the second largest external creditor in the world. It also happens to have a monstrous internal debt. Presumably those scales can balance for a while longer.
Share markets as a rule of thumb don’t like rising interest rates. One thing we know for sure iscentral banks will do everything to keep interest rates at an artificially low level.
This makes stocks look more attractive. They look even more attractive when you consider that central banks have made it clear they prefer the ‘wealth effect’ of higher stock prices. In fact, you could make a case that they have removed the equity risk premium from the market with an implied backstop.
Does this make the long term case for stocks as less risky than in a pure free market? You could certainly argue it – until the bubble bursts.
Since we have no way of knowing when that day of infamy could come, sitting on the sidelines as currencies depreciate, or holding only a pile of gold, doesn’t sound a great wealth building strategy either.
We agree with the note Kris sent us: ‘If you want any chance of making money from this craziness you have to take part in it, but protect yourself knowing it could end at any moment.‘
Editor, Money Weekend
From the Port Phillip Publishing Library
Special Report: How to Buy Better Stocks
Markets and Money: More Background Noise From Ben Bernanke
Money Morning: The Day Japan and China Shook the Aussie Market
Pursuit of Happiness: Fight the Tax Man, Invest in Dividend Paying Stocks