How Rising Tensions in Asia Might Have a Serious Impact on Your Portfolio
The recent developments in Asia are a good lesson in showing investors that the task of making investment decisions is not an easy one. The cross-current of multiple variables can result in shifts in investor sentiment that are not obvious, at least initially. Let’s take a look at several events that have just occurred in both Japan and China.
The market view regarding Japan has been consistent for many years—the country has basically economically flat-lined. The decrease in the population is severely hampering the economy’s ability to grow. On top of that structural problem, the crisis in Europe is actually causing a flight into the Japanese Yen, causing it to be seen favorably in terms of investor sentiment as a “safe” currency (which is ridiculous when one considers their sky-high debt/gross domestic product, or GDP), and this rise in the yen has hurt the country’s export sector. All of these factors and many more, including their need for energy use, has put pressure on the Bank of Japan to help the economy.
Last week, the Bank of Japan expanded its monetary stimulus program to 10 trillion yen ($124 billion), bringing the total to 80 trillion yen. The initial market view in terms of investor sentiment was a decrease in the value of the yen, which makes sense. However, shortly following this initial move, the yen began to strengthen, contrary to what the common market view would be in this case.
In my opinion, this is resulting from rising tensions between Japan and China. For many of us in North America, we’re unaware of how long and deep the complicated relationship is for these two nations. While investor sentiment might be focused on pure numbers, this territorial dispute, which is located in the East China Sea, is now spreading to mainland China, hurting trade and business relations between China and Japan.
Posted in the China Daily newspaper, normally associated with the Communist Party, the latest threat comes from a senior Chinese advisor of the Chinese Academy of International Trade, Jin Baiong; he stated that China should retaliate against Japan’s claims for these islands by attacking the Japanese bond market (by dumping their massive holdings) to create a funding crisis, a scary thought in terms of investor sentiment.
In recent days, many Japanese businesses in China have been attacked and the market view is now shifting toward realizing that this spark could inflame the region in a very severe crisis. Investor sentiment in North America should become more cognizant of the increasing dangers that this localized threat can escalate. Don’t forget, the U.S., while technically neutral, has placed Japan under its nuclear protection and has extensive use of its land for American military bases. Already we’re seeing Chinese military stocks soar as that nation increases its military spending and now there are reports that the Japanese want to increase spending on their own military capabilities.
All of these tensions have created an interesting twist in investor sentiment, as the Japanese yen has started to increase in value despite additional monetary stimulus. Although it is hard to know for sure, I believe that this is a result of the repatriation of funds by businesses and investors. For example, with investor sentiment now quite bearish for Japanese firms in China, they are pulling their investments and funds out and bringing them back home. While this market view appears to be logical, this can have terrible consequences over the long term.
The world economy is on the edge of another recession and the market view has been quite poor over the last few years—for good reason, obviously. There needs to be more trade and an increase in business confidence, not higher tension levels and a decrease in transactions worldwide. Investor sentiment in North America should be aware that if the crisis worsens, the Japanese-Chinese relationship can hurt stocks here as well. While the market view on American stocks is positive, given the recent high levels mainly due to additional monetary stimulus, that only works if businesses use the excess funds to expand and grow. A world in which tensions are rising could cause a shift of allocation toward military spending. Obviously, the worst-case scenario is for an outright war between China and Japan. While it is unclear how the U.S. would respond, more uncertainty is not a good ingredient for investor sentiment.
This brings me back to one overriding principle that has been true since the beginning of time—we can’t ever accurately predict what will happen in the future. While the prevailing market view was that Europe would be the cause of the global economic recession, perhaps it’s actually in an area that no one predicted a year ago—a conflict between Japan and China.
Nassim Taleb, who I recommend everyone read, has brilliantly and eloquently written about the “black swan” theory: the events that have the highest impact are those that are hard and almost always impossible to predict. This rareness makes it impossible to compute, meaning that investor sentiment always misprices the probability of their potential occurrence and effects. After all, who could have predicted the Internet 30 years ago and how it would have changed life? It seems obvious looking back, as hindsight is always 20/20. The market view should be more cautious, because historically in human nature, investor sentiment is akin to a pendulum, swinging from overly bullish to overly bearish.