Wednesday, October 18, 2006

BoJ v. DIC: Who's Got the Hot Hand?

Mizuho Securities reported in their latest 4th quarter strategy summary that Japanese public entities (The BoJ, the DIC, and the BPSC) held roughly YEN 7 trillion (nearly USD$65 billion) of listed stock.

Interestingly, the DIC (Deposit Insurance Corp) held on a cost basis YEN1,795 Billions primarily "acquired" from the less-than-illustrious though once-mightly NCB & LTCB, the former who was one of the largest writers of Put Options on the Nikkei 225 at the Pinnacle of the Bubble. Likewise, the BOJ bought YEN 1,974 billions of stock at cost from it's accumulated interventions and market pecadilloes. The DIC, as of Sept book closing was showing a market value of YEN 1,780 billions - for a loss of YEN 15 billions which is rather surprising given the breadth and depth of the bull market over the past four years. The BoJ, by contrast, shows a market value of their acquired holdings (basis the same Sept book closing) of YEN 3,565 billions - netting them a cool YEN 1,591 billions (USD$18 billion) of profit for the People of Japan, who with a >6% of GDP fiscal are in need of additional revenues, whatever their source.

All which leads one to ask the burning question: what is their secret? Who is their hot-hand? To be fair, the BoJ acquired most of their stock at the pitiful depths of bear despair in 2002 whereas the DIC acquired theirs in the mini, but narrow bull of FY 2000. Moreover, it is likely that both LTCB and NCB - both lacking long historical Keiretsu's - ending up with little less than poodle-shit in their portfolio, something the DIC must eat as lender (and apparently buyer) of last resort. Yet it is worth fathoming just HOW BAD their stock selection must have been to effectively make no mark-to-market money whatsoever during the past 4-year bull market which has been of a breadth and scale not seen since the 1980's - more than two and a half decades now-passed.

Charlie's War & Yen Market Shenanigans

I just finished reading "Charlie Wilson's War" about the enigmatic Texas Congressman's championing and funding of the Afghan Mujahaddin's fight vs. The Soviets in Afghanistan during the 1980s. Some even go so far as to extend to Congressman Wilson the honor and credit of single-handedly being responsible for the destruction of the Soviet Empire. Eye-popping stuff, indeed. But much of the sordid details are not entirely unexpected for the slightly cynical. Grand conspiracy? No. But nonetheless, what one learns is that whatever was rumoured to have happened, or whatever deeds the CIA was alledged to have been undertaken, or whatever horse-trading one might insinuate to have been responsible for the legislation, money and events that followed was not only true, but more colourful and entertaining than anything a conspiracy theororist might have imagined in their wildest fanatsies.

Which brings me to the subject of the Japanese Yen and deflation. Here your faithful seer and prognosticator, "Cassandra", has been brutalized by the neo-mercantilist apologists for Japanese & Chinese fiscal, monetary and international economic policies that have - at leastly partly - perpetuated and exacerbated global imbalances. First hog-tied by a mysterious, arrogant and dismissive Asian economist (perhaps one who himself works for the Chinese government or such) followed by a pummelling from an official at a Japanese lobbying organizations active in advocating Japanese Policy to foreign governments, all for having the audacity to suggest that Japanese deflation has been whipped and is (and has been for a little while) a problem no longer, and that we find ourselves in our current predicament of "sticky", non-correcting exchange-rates, not as the result of happenstance, serendipity or for that matter, benign neglect, but as a result of conscious policy action in both China and Japan.

Seething dismissive derision was the resulting response. "Deflation is evil and causes AIDs, not to mention Nuclear Proliferation!", he chimed. "No one can live with it!". "Everyone will suffocate". And therefore, "No economist can understand what your suggesting!". His partner took over: "Conspiracy theorist!" "Prove it", he taunted, as he went on to explain that rather than being a conspiracy of the type our Cassandra suggested, it was actually the result of a different domestic policy conspiracy of the type he favored, one in whihc the Japanese Yen was simply innocent road-kill on highway of pacifying the farmers. All I suggested was that there were plenty of good reasons to believe that many prices in Japan should have fallen, and for that matter, still be falling. And that combatting this fall with ZIRP-tastic monetary policy was not only difficult, and unwise, but terribly uncivic-minded as far as the international monetary system goes. About as useful as putting out a candle with a high-pressure fire hose.

All which brings me back to the CIA. And Oliver North (remember him?), Charlie Wilson and Gust Avrakotos, the hero (of sorts) of the aforementioned Afghan story. You see, they did do all these things. Despite Jimmy Carter and the new moral foreign policy. The CIA did (and does) have fat balding paedophile-looking guys thinking about devious ways to blow-up our enemies, running proxy wars and destabilizing regimes just as the KGB was behind the Bulgarian assasination of their lliterary dissident in London with the funnny poison-tipped umbrella. And there were ideological wackos in the Pentagon thinking of ways to subvert Congress' will to NOT fund the Contra, by, yes, of all crazy schemes, supplying arms to anti-American Iranian mullahs (to fight Saddam who we were also supplying) in exchange for the Iranians giving money to the Contras. Silly as it sounds, people thought it was, at the time, sound and so it happened. Calmly and calculatingly, and stupidly.

In modernity, where "war" between advanced industrialized countries, and increasingly all nations, is often fought economically, financially, and in the realm of trade, it should come as little surprise that successful nations are doing everything possible to gain parochial advantage for their people and their corporations, through every means possible, including intervention in, and the resulting manipulation of, international money markets. And Japan is the King in this respect. After all, "PKO" (Price-Keeping Operations) only has meaning in Japan - something which saw government authorities indirectly and directly hoover-up many trillions of YEN of stock from all comers. Think Eisuke "Mr Yen" Sakikibara, who massacred dollar shorts and engineered an appreciation from the excruciating depreciation torture engineered by Secretary Rubin. So today, think of the double-talk of Tanigaki, lambasting the BoJ on every occasion for even hinting rates might rise. Or BoJ officials, even today, frantically denying stories they might be even gathering data on the potential size of the carry trade. "No! No! Absolutely Not!!!" "We have no idea, no such intention, and we do not care....."

Yeah, Right!

Friday, October 06, 2006

Change of Heart: Bring It On, Dude

I've changed my mind. In an epiphany (of sorts) overnight, I have dramatically shifted my mindset from one of "outrage" and "blame" regarding neo-mercantilists' self-serving treatment of the international monetary system to a "take charge"attitude of "Bring it on Dude - The More The Better". Let the Japanese and Chinese play their petty mercantilist games, but we too can play and win. They may have won this battle whereby they escaped with a sizable amount of America's manufacturing base, but looking forward with some skill, scheming, and Muhammad Ali rope-a-dope tactics, American can yet win the war.

Here is my plan: America should subsidize and encourage Disney, Dreamworks, etc. to dump as much Bambi, SpongeBob and "Friends" as well as Video games (e.g. Grand Theft Auto) upon China & Japan. Encourage their piracy for THEIR domestic markets - since the more distribution the better. The lamer, more hynotic and saccharine the plot, the more we should encourage its consumption. Next, we should subsidize and encourage the export of our world-class Processed Food. Oreos. potato chips, Nacho-flavored Bacon Bagels, Chocolate Chicken Nuggets, TV Dinners, BigGulp Sodas, Campbell Soup, Philly Cheese Steak Pizzas, and loads and loads of ice-cream. With fertility rates already low in Japan & China, and their darling little spolied children already over-indulged getting fat and lazy, hanging about in Yoyogi Park dressing like Elvis and slacking with computers & pop culture, we are already half there. Then we need to send them skateboards and snowboards. And perhaps AC/DC or The Scoropions, Kurt Cobain or something else rad to accompany it. Gen-X-J & Gen-X-C!! Brilliant, huh? Oh a couple of more things. We need to train lawyers for them. Lots and lots of lawyers. If we can get their lawyer-to-population ratio up to where we are in the USA, we can really throw a proverbial spanner in their works. And we should try to teach them the benefits of LObbying within government giving them the whole spiel on aggregation of interests and how it breeds efficiency. Maybe they'll bite. Finally, we must encourage the promulgation of CNBC China, and stealthily encourage E-Trade & all manner of on-line brokers to expand & grow in Asia. We could even send Maria Bartiromo over there and make trading "free". The combination of hypnotic pseudo-financial news and essentially "free" on-line gambling coupled together would be absolutely toxic and would grind work and efficiency to a slow halt since we know that both cultures are already inveterate gamblers. Together, these things, in the absence of government policy, will drive convergence on the Asian side.

But that's only half my plan, not to mention half the battle. Causing convergence on the eastern edge of the Pacific will be tricky, and for this we must use reverse psychology and counter-intuitive methods. The USA must encourage the Asians to continue to accumulate dollar reserves and make our dollar even stronger. We will at once both raise rates, and taxes upon the rich to ease our fiscal deficit. This will cause the dollar to soar and will be like putting one's balls into a vise and squeezing. The dead will awake from the excruciating cries of pain, but this time something different will emerge. Not the historical moaning and whinging about cheating and unfair competition, but a John Wayne-like gritty determination to figure out ways to compete and win. Whereas in the past companies simply up and left, moving to China, this time they'll stay and fight. Like in Iwo Jima. Or the beaches of Normandy. This time, like the Japanese and the Germans, capital will take a haircut on returns and invest in training, new and more efficient plant & equipment, while management takes across-the-board paycuts, especially at the executive levels. Labour too will work longer, harder, more efficiently discarding all remnant lines work demarcation that are vestiges of the UAW and labour struggles of the past. And most importantly, management, labour and capital will work together to figure a way to best their neo-mercantilist competition. The Federal government will also pitch-in. They'll unburden companies of their current and legacy pension and healthcare obligations, finally placing US companies on equal competitive footing with their European and Japanese counterparts, and taking a huge burden off of the day-to-day worries of labour, finally letting everyone focus on how to improve and get better, cut the fat, make production processes leaner and more intelligent, with less waste. They can also perfect the Japanese art of "our rice is different" and "your meat smells funny", or the Chinese skill in protecting "key" or nascent industries from competition, by resurrecting any number of non-tariff barriers, security checks and port-controls for Asian cargos to make sure there are no Zerba Mussels or Japanese Beetles aboard. Americans have historically been up to meeting a challenge. But the narcotic effect of affluence, unrequited indebtedness (and, yes, Taco Bell) have numbed our ability to respond to a such an important challenge. In fact they've even numbed our ability to know we're being called out!.

America can regain her competitive feistiness, but it will take pain. Not pain for the sake of masochistic pleasure, but pain for the sake of regaining our senses. How can one know pleasure if one doesn't feel pain? How can we overcome our parochial selfishness if we are not forced by circumstance to work together?? Ok besides meditation, is there a route? And in an increasingly hedonisitc world, this lack of ability to sense and react accordingly will be our undoing unless she can regain a sense team spirit, rejuvenate her ability to manufacture, innovate, and compete effectively, and collectively rise to the occasion.

Wednesday, October 04, 2006

Pirating, Buccaneering & Steeling

The news that Tom Hudson's Pirate Capital, and his aptly-named "Jolly Rogering Fund" were taking some heat last week was no surprise (to me). Hudson's operation runs what is professed to be an "activist" fund. This effectively entails buying a wodge of an albeit "cheap" or otherwise unloved stock, ramping the price as much as one can once one has bought the line. Then publicly professing one's [affection, admiration, recognition of value] for the [company, business, sector] while simultaneously (and again publicly) expressing one's disaffection with [management, CEO, share price performance, business strategy]. For those with lots of their own money, secure credit lines, a keen eye for value, and a reasonably deep reservoir of patience, this can be rewarding as Nelson Peltz recently demonstrated with Heinz. But the equation is entirely different IF one is an agent, employs fickle forms of leverage, is subject to frequent SEC reporting, and is at the whims of market liquidity and redemption cycles that differ from one's possible duration. This caveat is NOT for the manager for he is popping the Veuve Cliquot and flying private so long as investor just show up in his fund. He it must be said has the trader's option. For his capital "partner" on the other hand, it is an entirely different equation.

In the extreme, an activist's attention results in a quick sale of the company at a premium allowing one to exit the entire position, in cash, at a nice profit as was the case for Pirate & ski resort operator, Intrawest. However, this is the exception rather than the rule. More frequently, one buys a position, ramps it a bit, grabs a positive mark-to-market, leverages that to raise more assets and if he is smart and lucky, accrue and collect fees from an irreversible quarterly high-water mark. That is sweet, at least for a swashbuckling investment manager. What follows is: (a) he's "spent his ammo" or "shot his load" so to speak (b) passed the filing threshold (c) used his PR splash to exhort to the world his intentions (d) is now left with an unconscionably large and unmarketable position in a stock of dubious longer-term merits.

Often, the targets are flawed, which is why they are "cheap". They are in declining segments, facing stiff low-cost competition, or perhaps have not invested as they might have. Stale longs and short-sellers notice that the stock has gone up. It's elevated price now often deters value investors, as well as potential trade or private equity buyers. Basically, one has put lipstick on a pig, but it remains a pig by any other name. The financial privateer must now:(a) pray for a stock-specific or market tailwind to keep prices elevated, (b) collude with other pirates, (c) buy more of the same stock - prefarably at the end of the week, month and quarter to avoid losses and redemption cascade that will inevitably follow if he fails in "a", "b" &/or "c".

Now if our Corsair is fortunate, he will score a few extra-base hits, or home runs AND the market breeze will carry and reward one's accumulated positions. The virtuous circle of returns->new investors->new capital->buying more of the same->returns->new capital and so-on continues so the manager, now Master-of-The-Universe can speak authoritatively at conferences about the tremendous market opportunities there is, the virtually unlimited capacity of his vision (and his Fund), the unbounded opportunities that will open up in China as well as the social good he is doing for the world not to mention the untouchables in Calcutta. After all, Hedge Funds CARE, you know.

But as anyone who has been around can tell you, "shit happens". LTCM, 1987, Gulf Wars, fraud, panics, scares, regulatory changes, recessions, depressions, devaluations, hemorrhoids, your entire research staff walking out, you name it. Then like a frigate under attack, one is subject to the unvirtuous circle. Because something happened, one's positions come under pressure causing poor performance. Investors redeem causing one to necessarily sell positions, causing their prices to fall, causing one to lose more money, causing more redemptions. Somewhere in between all this, depending on the shit that has happened, the market, too, begins to gun for the positions of the once Master-of-the-Universe. The positions then return to the realm of "cheap getting cheaper" and once again might enter the sights of the private equity or deep value guys who invariably have more capital, more "principal" and less "agency", more patience, and less hubris.

Publicity-shy Warren Lichtenstein (and friends) were the group that seized the day in Japan. Though Yoshiaki Murakami's MAC may have made more headlines as a former MOF-man gone renegade, it was Steel that actually made the buckets of money - at least on a mark-to-market basis, and collected the fees in cold hard cash. There are three types of activist in Japan. First there is the "cooperative" ones that take a big line in a cheap company and truly desire to hold it for investment purposes. Silchester, Wilbur Ross's Taiyo Fund fall into this category. They let everyone one the object of their eye is "cheap", but they don't shake down management, though they do buy more at higher prices when "opportune". The second type is SFP or Symphony Financial Partners. They buy really shitty businesses and crappy companies at ostensibly knock-down prices. The companies may have some redeeming quality such as a crown jewel of undervaluied real estate, or sub-book valuation, or excess cash they could return to shareholders if management were so inclined. There performance is entirely self-generated and this is effectively a market impact trade or ponzi for the really cynical. They cannot exit without destroying 50% of the market value, which is often the same amount of market appreciation they created when they bought their shares at higher and higher prices. If held, this trade is effectively a race to the death of when the company will burn, or mis-use, or write-down the value of their cash, investments or assets.

Steel Partners is the third type, that combines the first two. They adopted a portfolio approach and bought stakes in all the net-cash companies that were low hanging fruit. They bought more shares at higher and higher prices to generate mark-to-market profits that created the aforementioned "virtuous circle". Then they made public bids for a few companies to demonstrate that they were serious. Of course they had no intention of consummating the deal, and almost certainly had no interest in running a Japanese company. The bids accomplished a few things. They forced some change that might be construed as "good" from a passive shareholders point of view, but ultimately bad for an investor in Steel who was now an oversized holder of an unmarketable position in a once-cheap, but now pedestrianly valued security. Sure Steel has a large mark-to-market gain (which Steel collected incentive fees upon already). Sure the dividend is high, but with six-months trade of an average day's volume, one would have to take a massive haircut to liquidate. Moreover, at present valuations, many of the companies hold little appeal to private equity or trade buyers.

So what does the future hold for activism in Japan? Eventually, there will be more successful hostile deals, like the Hankyu-Hanshin merger. But they will be made by private equity firms or trade buyers who desire to actually strip out the cash and assets, run, merge and/or subsequently flip the company back out to the unsuspecting public market with negative book value. They will encounter resistence along the way from all the constituents, including the authorities who desire to keep the "wah" of the house in tact. But before then, perhaps during a capital dislocation event that is as yet to emerge, it is my forecast that Steel Partners and the other parasitic activist flippers who don;t really want to get their hands dirty, will be the victim of the most unbecoming unvirtuous circle, like the one we see unfolding today at Pirate's not-so-jolly Fund.

Monday, October 02, 2006

Denial is a Team Sport

Here we see a sign outside the Finance Ministry in Tokyo. It alerts everyone to the August Ministry's location and it roughly translates into English something much like: "Do not show us the truth inside these wall because we do not wish to see it; do not speak the truth inside these walls, for we do not wish to hear it; and do not wait for truth to come from our lips, for we have no intention whatsoever of uttering it - not at least to smelly Americans or pig-dog Chinese". That is a paraphrase of course.

Such a sign is not surprising for with the the Euro again reaching new highs versus the Japanese Yen (see adjacent graph), even as the Eurozone slides in to deficit v. Japan & China both and the Japanese continue to rack up prodiguous surpluses against everyone except OPEC, we see Japanese consumer prices & property prices rising smartly, unemployment falling, and, most recently, releasing a most optmistic and promising Tankan survey, it is worth contemplating how deeply cynical such parochial selfishness and team denial actually are within Japanese policy.

Japan-o-philes and Nippon's other apologists will point to now-laughable threats of continued deflation (certainly if viewed relatively for Japan shares the same global economic risk as other OECD nations), or the need to keep rates low just in case deflation rears its ugly head again. But by now, these are so obviously just tired, lame, recycled excuses for TeamJapan to avoid doing its part in making any concessions in the desperately-needed global move towards rectifying global imbalances.

In the meantime, they seem intent (and rather pleased with themselves, I must say) to beggar jobs from Europe at an increasing pace, and the United States at a decreasing pace, and do their utmost to insure that the Chinese do NOT get the upper hand by somehow outlasting Japanese efforts to prevent the YEN from abandoning it's tether to the USD before the RMB. And so they will continue with ZIRP, a bloated fiscal policy with 6 or 7% of GDP deficits, and insure YEN is the finance currency of choice for everything from USD denominated bonds, any higher-yielding soverign & junk, a new kitchen or beach-home for the Hedgies of Greenwich, as well as a new flash fab in Milipitas, CA.