Wall Street woke up to grim news on Thursday morning (today) - overnight the Japanese stock market, as measured by the Nikkei index, lost a stunning 7.3%.
The sudden drop caught many investors by surprise, as the Japanese stock market had risen 50% - 5,277 points - so far in 2013. The Nikkei plummeted 1,143 points Thursday to close at 14,483.98.
The shock waves were felt in stock markets throughout Asia and Europe, and caused the Dow Jones Industrial Average to shed 100 points in early trading.
Analysts blamed a combination of poor Chinese manufacturing data and mixed messages from the U.S Federal Reserve Wednesday about when it might slow its monetary easing, which caused Japanese 10-year bonds to briefly rise above 1% for the first time in a year.
But those factors "just added fuel to the fire," said Money Morning Chief Investment Strategist Keith Fitz-Gerald, explaining that there's far more lurking behind this plunge in the Japanese stock market.
"The rise in the Japanese stock market was unsustainable," Fitz-Gerald said. "It was a bug in search of a windshield."
Japanese Stock Market Propped Up By "Abenomics"
Fitz-Gerald said that the Japanese stock market, like the U.S. stock market, has been artificially inflated by the easy money policies of each nation's central bank.
The surge in the Japanese stock market coincides almost exactly with when Prime Minister Shinzo Abe took office in December and directed the Bank of Japan to launch a bond-buying
binge triple that of the Federal Reserve's.
But that policy is just piling more debt on top of what Japan already owes. About 25% of the Japanese budget already goes toward interest payments on the government debt.
And Fitz-Gerald said that if you include all types of debt - public, private and corporate - it adds up to 500% of the island nation's gross domestic product.
That's one reason the Japanese stock market panicked when Japanese bonds rose above 1%. With such a tremendous amount of debt, the country simply can't afford to have interest rates rise.
What's more, Fitz-Gerald said, banks and hedge funds around the world have placed bets on the Japanese debt using credit default swaps - a bet that pays off if Japan defaults. Credit default swaps are like buying insurance on someone else's property, and were blamed as the primary cause of the 2008 financial crisis.
Financial entities trade sovereign debt like Japan's using CDS - an opaque and dangerous activity that threatens markets around the world.
This week's drop in the Japanese stock market was just a taste of what could happen given the toxic brew of ever-rising sovereign debt in places like Japan and Greece combined with bigger and bigger CDS bets that those countries will default on their obligations.
"We're guaranteed a repeat of this episode," Fitz-Gerald said, who expects the Nikkei to resume its climb upwards in the short term. Long-term is a different question entirely.
"How long this can be sustained, I don't know," he said. "Someday the markets will answer this question for us - suddenly and with no warning."
What U.S. Investors Need to Know About Japan
Fitz-Gerald has long cautioned U.S. investors about Japan.
"Since we've been there since the end of World War II, investors are comfortable with Japan. They think they know it," Fitz-Gerald said. "But it's an illusion of safety."
Fitz-Gerald, who is an expert in the Japanese markets and even lives there part-time, said most investors should avoid Japanese stocks and bonds despite the attractive run-up in prices because when the music stops, they won't be able to get out in time.
Instead, he said, investors should short the Japanese yen via the ProShares UltraShort Yen (NYSEArca: YCS), a trade he first suggested to subscribers of his Strike Force trading service in February 2012 - a full eight months before renowned investor George Soros began touting the trade.
Anyone who took Fitz-Gerald's advice is up nearly 70% now. Those who got in when Soros did are up just 20%.
But Fitz-Gerald still sees more weakness - and opportunity - in the yen. He predicts it will eventually drop as low as 125 yen to 150 yen to the dollar.
To find out more about Keith Fitz-Gerald's Strike Force, click here.
Related Articles:
- Money Morning:
Three "Abenomics-Proof" Investments - Money Morning:
Can Kuroda's New Round of "Easy Money" Finally Revive Japan? - Associated Press:
Japan stocks dive as benchmark bond yield spikes - The Wall Street Journal:
Japanese Stocks Fall 7.3%
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About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.