« The euphoric hope held by many in the market, that “this time is different” in Japan, will once again be crushed by the “Iron Coffin Lid” that is Japan’s structurally weak economy. »
Last week, Japan’s Nikkei 225 index enjoyed its longest winning streak in history which eventually ending after 16 consecutive days of gains, only to resume rising after a brief one day hiatus. And, as foreign investors once again flood the Japanese stock market, chasing the momentum which has pushed local stocks to levels not seen since 1996, the question on everyone’s lips is how much longer can this continue?
Offering a decidedly downbeat outlook on Japan’s market exuberance, Shannon McConaghy – portfolio manager at what we have in the past dubbed the world’s most bearish hedge fund, Horseman Capital Management – believes that the euphoria is about to end. The reason: the ominously sounding « Iron Coffin Lid. »
In a note released late last week, McConaghy writes that there has been a lot of excitement over Japanese equities of late, with hyperbole from the sell-side, and others interested in promoting Japanese equities, becoming extreme. However, he cautions that « there is not a lot of discussion around the risks to Japanese equities from current elevated levels » and adds that « one observation I would make is that Japan has risen to these levels on a number of occasions over the last 25 years, only to fail spectacularly each time against what is referred to, by some in the Japan markets, as the “Iron Coffin Lid”. History suggests it is far better to be short Japanese equities from these levels than to be long. »
So what is this Iron Coffin, why does it have a lid, and what happens next?
Below is a visualization of this « Iron Coffin Lid » effect: it shows the key resistance level in the Topix beyond which the index has failed to progress every time in the past quarter century.
There’s more than just a chart however: here is Horseman’s take on why this latest rally in Japanese stocks is also set for disappointment.
For those unwilling to outright short, I would point out that historically Japan has had meaningful underperformance following past bursts of outperformance. In these periods it is particularly appealing to short against longs in higher growth areas. Japan also provides amplified short returns during global down turns. As such it can be a low cost but high return hedge to risk-off impacting long positions elsewhere. One way to identify when Japan is about to provide its greatest periods of underperformance is when its market capitalisation exceeds its Gross Domestic Product (GDP).
