News: Lack of Japanese Outflows Puzzles Yen Bears

It makes perfect logical sense.  Lower yields in Japan engineered by the BoJ's new easing program ought to induce Japanese investors to seek higher yields abroad.  Under this scenario, the necessary Yen sales to execute these trades ought to send JPY even lower, as real money initiates short Yen positions along with speculators.  There's just one problem with story though, it hasn't happened.  Japanese capital is staying home.  Despite warnings from inflation hawks, BoJ policy has yet to drive Japanese investors into risky foreign outlets.  

A Soaring Nikkei 

The Bank of Japan policy has already been an unabashed success for one segment of Japanese society: equity investors.  Since the election of the LDP government in December, Japanese stocks have soared nearly 50 percent, as evidenced by a 4000 point jump in the Nikkei index from 8500 to over 13000.  This unprecedented rise in a major equity index has even caused many foreign hedge funds to go over-weight on Japanese stocks in the hopes of cashing in on the wall of money being unleashed on the markets by the BoJ.  Ironically, these represent inflows into Japan, not outflows.  Indeed, even an unhedged long Nikkei position is well in the green despite Yen weakness.  This year, in US dollar terms, the Nikkei has returned over 11 percent. 

Ultimately, such a bull run in stocks gives the Japanese investor little reason to seek returns aboard.  Why go through the added effort of studying foreign companies and governments, possibly through linguistic and cultural barriers, when such handsome profits can be reaped on the local stock market.  We saw the same phenomenon in the US as the Federal Reserve eased credit during the Great Recession.  Despite predictions of massive capital flight followed by a collapse of the dollar, investors simply shifted out of bonds and into high yielding defensive stocks.  Nobody bought higher yielding Cetes (Mexican government debt) or Canadian bonds. To the contrary, many of those investors, spooked by the global downturn, brought money home.  

Home Bias Returns 

In the end, most investors, including large institutionals, just aren't savvy enough to make foreign investments. In the face of uncertainty, people go with what's familiar every time.  For the Japanese investor with a large bond portfolio, shifting into local stocks is much less scary than buying risky or exotic foreign debt.  This trade, so far, has also been incredibly profitable.  Markets are driven by human beings, and sadly many human beings make investment decisions based on emotions, personal predilections, or outright prejudice.  You wouldn't believe how many otherwise savvy investors still see Mexico as an economic wasteland.  In the long run, markets may be rational, but they are hardly efficient.  It takes years markets to reward sound economic management in developing economies.  The fact that the Mexican Peso is still trading so far below PPP is case in point.  In the end, the fact that so many investors are unwilling or unable to do the research to take currency risk results in some tremendous bargains for those of us willing to do the work.