Market Overview

Japan Warned of Possible Downgrade

Standard and Poor's affirmed its AA- rating for Japan, while maintaining a negative outlook for the country. The credit rating agency also warned that Japan could be downgraded if its public debt continued climbing higher or if the Japanese economy grows more slowly than expected.

One of the reasons that Standard and Poor's is concerned is that Japan has the highest public debt to gross domestic product ratio of any industrialized economy. Although Prime Minister Yoshihiko Noda has proposed raising the sales tax from its current level of 5 percent up to 8 percent in 2014 and then to 10 percent in 2015 in order to improve the Japanese government's financial health, it could be difficult for him to do so because his popularity is falling and his Democratic Party lacks the votes needed to push the tax increase through Japan's parliament.

The Japanese opposition says that it is concerned that raising taxes could undercut Japan's efforts to boost economic growth. Resistance to the tax increase could grow even stronger because it was reported just last week that Japan's economy shrank during the last quarter of 2011 and the country announced today that its January trade deficit surged to a record high of 1.48 trillion yen ($19 billion). If Japan's economy doesn't show signs of strength soon, the chances of implementing the tax increases could drop significantly. Even if the tax increase makes it through parliament, it could have the unwanted side effect of undermining economic growth.

A downgrade by Standard and Poor's is made more likely because focusing efforts on Japan's high public debt could undermine the country's economic recovery and focusing on boosting economic activity could push the deficit to even higher levels.

Standard and Poor's also noted that reducing the public debt and improving economic performance would have no affect on Japan's aging population. As Japan's population ages and families have less children, Japan's tax base will become smaller while welfare spending on the elderly increases. So even if Japan is able to avoid a downgrade in the short term, the country has yet to deal with its much more serious long term demographic issues.


ACTION ITEMS:

Bullish:
Traders who believe that Japan will be able to successfully perform the balancing act of reducing its deficit while supporting economic growth might want to consider the following trades:
  • Buying Japanese stocks like Mitsubishi UFJ Financial Group (NYSE: MTU), Sony (NYSE: SNE) and Hitachi (NYSE: HIT) could prove profitable if Japan's economy improves and steps are taken to reduce its debt burden.
Bearish:
Traders who believe that Japan will not be able to make its economy grow stronger while raising taxes during a time of falling exports may consider alternative positions:
  • The ProShares UltraShort MSCI Japan (NYSE: EWV) ETF should see its share price move higher if the Japanese economy continues to disappoint and Japanese politicians are unable to cooperate.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

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