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Hello. Inflation remains the subject of the hour, day, week, month and year. But sometimes we all need a break. So Unhedged took a day vacation in Japan and returned the postcard below. We are very excited to hear if readers think there is any money to be made in the Japanese markets. Write to us at [emailÂ protected] and [emailÂ protected]
The country where value investors will die
Here is a happy little table:
The Japanese stock market has almost tripled in nine years! Even typing that phrase seems weird to me, as the Japanese market has been the mainstay of Wall Street jokes since at least 1990, when that country’s epic bubble burst.
For 30 years, brokers and fund managers have hammered one table or another over how Japan had large companies trading at low valuations. International investors took stakes in dying Japanese groups and pushed for shareholder-friendly Western reforms. A few have made money. Most were punched in the face and sent wrapped up.
And the joke isn’t quite over yet. Convert that happy little yen chart to dollars and add the S&P 500 and MSCI World, and you get this unhappy little chart (all three are rebased to 100):
And, of course, the longer-term story for international investors in Japan has been nothing short of horrible. Here is that last graph again, this time in 1975:
Long experience and recent performance have left global investors very reluctant to bet big on Japan. This chart from Bank of America shows (in the small light blue lines) the net percentage of overweight managers in Japan (that is, the overweight percentage minus the underweight percentage). The dark blue line is a measure of the dollar performance of Japanese stocks relative to global stocks:
A net 7 percent of managers say they are overweight Japan (current figures for the US and Europe are 16 percent and 34 percent, respectively). Several years of sustained interest that began in 2012, coinciding with the start of Abenomics, have all but disappeared.
The underperformance, of course, left Japanese stocks attractive at low prices. Almost half of the Topix are trading at less than once the book value (and more than half of the index has no net debt). Below are the Enterprise Value / Ebit ratios for Topix and S&P. Japan’s discount is currently 50% above its five-year average:
But, again, it’s an old story. Valuations are the siren song that has led generations of investors into what has turned out to be a value trap – a relatively cheap market that has become relatively cheaper. But at some point, things might just change, and the best (not to say good) performance of Japanese stocks in recent years suggests that the tectonic plates could shift.
Even the recent strong but not-excellent performance comes with a caveat: it was heavily backed by the state. Since 2013, the Bank of Japan’s quantitative easing program has included the purchase of domestic stock exchange-traded funds. The BoJ now owns 36 billion yen ($ 313 billion) of shares (or about 5% of the total capitalization of companies on the Tokyo Stock Exchange). But the bank virtually stopped buying ETFs this spring.
In addition, in 2015, the government’s huge pension investment fund announced that it would double the target allocation to Japanese stocks, which was 12%. The reassignment is complete. Last year, 25 percent of the fund, or 47 billion yen, was in domestic stocks.
Thus, the demand previously provided by the BoJ and GPIF must be replaced if Japanese equities are to gain another head start. The obvious candidate is international buyers looking for value. But they need a compelling narrative to buy into. Evaluation is never a good enough reason to buy.
Pelham Smithers of Pelham Smithers Associates argues that there is an exceptionally strong market within the wider Japanese stock market. âOverall performance has been very poor, but large parts of the market have performed exceptionally well,â he says. Smithers highlights the excellent performance of various actively managed Japanese funds (to cite just one example, the Baillie Gifford Japan Trust has appreciated 440% in ten years, in pounds).
But can the market as a whole finally perform? “The question is whether the clunkers have fallen enough to no longer be able to curb the market, or whether the world champions have become too expensive?” Smithers said. He thinks the answer to that last question, at least, is no – citing as an example Tokyo Electron, an outstanding semiconductor company that trades very cheaply compared to its US peers.
Another argument for buying is that after years of resistance, Japanese companies may give shareholder value a slightly (slightly!) Higher priority. The Toshiba burst – which can lead to the sale of one or more of its shares to private equity – is the most striking example. This gives hope that other sclerotic conglomerates will dissolve.
Toshiba may be a special case, however, due to its history of scandals, strong foreign ownership, and the political sensitivity of its nuclear activities. Mizuho Securities points out that since the introduction of tax incentives for spin-offs in 2017, only a company other than Toshiba has benefited from them (Koshidaka Holdings, a “karaoke room operator [and] fitness studios for middle-aged women â).
However, Toshiba is not quite the only one to shake things up, as my colleague Leo Lewis pointed out to me. OK Corp, a supermarket operator, is in a bidding war with a rival, H2O Retailing, against another, Kansai Super Market. Shinsei Bank is combat a hostile takeover of the online brokerage firm SBI. An activist Singapore hedge fund finds itself in the middle of a deal between energy company Eneos, one of its subsidiaries, and Goldman Sachs.
For those – like Unhedged – who hope for greater adherence to shareholder capitalism in Japan, these are only glimmers of hope. But the change has to start somewhere.
A good read
New York University PhD student Francesco Furno has thought-provoking thought new paper (and abbreviated tweetstorm) comparing the corporate tax cuts of John F Kennedy and Donald Trump. He finds that most of Trump’s tax cuts went to shareholders, while Kennedy’s went to growth and investment. Why? Furno attributes it to the structural differences between the two pieces of legislation. Not all corporate tax cuts are created equal.