CIBC’s leveraged notes tied to JPX-Nikkei 400 designed to outperform a mildly bullish market

By Emma Trincal

New York, April 11 – Canadian Imperial Bank of Commerce’s 0% Accelerated Return Notes due June 2018 linked to the JPX-Nikkei Index 400 offer high leverage but no downside protection for short-term investors seeking to outperform the underlying index in a moderately bullish market, sources said.

The payout at maturity will be par of $10 plus 300% of any index gain, subject to a maximum return that is expected to be 14% to 18% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will be exposed to any index decline.

The index is distinct from the better-known Nikkei 225 index as it is more recent (it was first published in January 2014) and is composed of a greater number of constituents.

The JPX-Nikkei 400 index is composed of Japanese stocks of large, mid-size and emerging companies.

Stocks are selected based on market capitalization, with a 1.5% cap applied to the weighting of each component, in contrast with the Nikkei 400 index, which is a price-weighted index.

Rich valuations

Steven Jon Kaplan, founder of TrueContratian Investments, focused on the underlying asset class.

“Most developed markets in the world are overvalued at this time. Japan is no exception,” he said.

“This trade may have been worth considering a little bit more than a year ago when Japan was getting a lot of bad press. It was considered to be hopeless.”

He was referring to the correction, which also struck the U.S. markets during the early part of last year. Japan disappointed investors after three years of so-called “Abenomics,” a program of fiscal expansion, monetary easing and structural reform put in place by Japanese prime minister Shinzo Abe in the beginning of 2013 just after his election.

Japanese stocks rallied in 2013-15 on the view that Abenomics would revitalize the economy. But the results were mixed.

The index hit a high in May 2015 at 59.04 and dropped in February of last year along with the U.S. markets, said Kaplan.

Recently the JPX Nikkei 400 index retested its previous May 2015 high but failed to break out above it, settling at 56.98.

“When people look at the chart and see the high of two weeks ago just below the high of May 2015, they think of a double top,” said Kaplan.

A double top is a charting pattern, which describes the rise of a stock followed by a decline, another rise to the prior high and finally another drop.

“I don’t use technical analysis much. But more likely this last top probably signals that more sellers may be coming in each time we get those levels. It’s not a chart pattern you want to see. It suggests that things may have gotten overstretched,” he said.

Downside potential

Kaplan is slightly bearish on most global equity markets in general. While Japanese stocks are not as richly valued as their U.S. counterparts, therefore less prone to a sharp downturn, the future direction of the Japanese equity market is hard to predict.

“We know one thing for sure: the Japanese, like the U.S., like most developed markets in the world are very high today by most standards,” he said.

“Everywhere the cause is the same: central banks have kept interest rates so low for so long, it has forced everyone to move their money out of the bank into the markets.

“Since we have crowded markets with many unsophisticated investors, once things go bad, people will end up panicking and selling very low.”

As a contrarian, Kaplan holds his own views about the U.S. dollar and interest rates. Both can impact Japanese yen.

“There is a consensus that the dollar is going to be stronger, rates higher and the length of the bull market longer.

“I’m not bullish on the dollar. Stocks have been down since early March. If the yen continues to gain against the dollar, the Japanese economy will take a hit.”

This would represent another reason to be cautious about Japan, he concluded.

Dividends

Tom Balcom, founder of 1650 Wealth Management, took a closer look at the structure of the notes, saying that he was uncomfortable with the lack of protection on the downside.

“Same risk as a long-only position but meanwhile you’re capped on the upside,” he said.

While having three times leverage was “nice,” it only allowed investors to outperform the index and the probabilities of doing so were slim, he noted.

“My concerns are you only outperform within a certain range; you don’t have protection; and you don’t have the dividends,” he said.

Another Nikkei

The iShares JPX Nikkei 400 is the exchange-traded fund that replicates the underlying index. Its dividend yield is 1.97%. Over the 14-month term of the notes, investors must forgo about 2.30% in dividends.

Balcom calculated that noteholders would outperform the dividend-paying ETF if the underlying price index had gained between 2% and 6% at maturity. He assumed a cap of 18%.

Any price return below 2%, including negative returns as well as any index appreciation above 6% would lead the notes to underperform the long-only position. These break-even points represents the levels at which the disadvantage of losing dividends and having a cap offset the benefits of leverage.

Forecasts

“I don’t see the notes as a replacement for that exposure because you’re only going to outperform in a narrow range,” he said.

“You’re going to underperform on the downside. You’re going to underperform if the index is flat. And you’re going to underperform if the index is up more than 6%.

“You really have to have a narrow view.”

Investors should not be bearish given the absence of any protection. They can only be mildly bullish as a result of the cap.

“You really have to have a range bound approach. Your forecast has to be spot on. Who knows where the Japanese market will be in 14 months?” he said.

Balcom said that he always asks himself what would be the advantage of buying a structured note versus investing in the equivalent fund.

“Your advantage here is the slight chance of outperforming the index. And for that, you’re giving up all protection plus the dividends as well as the liquidity.

“The first thing I tell my clients is: play defense. I have no protection whatsoever. Even if it’s not much, the ETF gives me more than 2.30% in protection via the dividends.

“Clients pay you to reduce risk in the portfolio, not to make forecasts.”

BofA Merrill Lynch is the agent.

The notes will price in April and settle in May.

© 2015 Prospect News.
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