By Associate Editor David Stevenson Feb 28, 2011
There's no point in beating about the bush. Japanese shares have been a rubbish bet for ages.
An investment in the Nikkei 225 "“ the country's most watched stock market index "“ would have lost you almost 60% in yen terms over the last 20 years.
In contrast the FTSE 100 is up by around 150% during the same period, even if it's only marked time over the last two-thirds of it.
In fact, just about the only redeeming feature about investing in Japan has been its strong currency. In the last two decades, the yen has nearly doubled against the pound.
But that's history. I wrote last month that Japanese shares now look very tempting. And here are two more reasons to buy...
Given Japan's ability to disappoint, it's little wonder that the country, as Charles de Vaulx of International Value Advisers puts it, "is... universally hated" by investors.
For contrarians, that's music to the ears. They know the time to buy a market is when it's heavily 'oversold' "“ and when people have given up hope of it ever rising again. Japan fits the bill. So there's loads of scope for investors to reverse their antipathy and pile back in.
But this swing in opinion won't just happen. It will need a spark. The Japanese market's drop now arguably provides good enough grounds for buying in by itself, as we'll see below. But even better, two more reasons "“ one short-term, another longer run "“ are also emerging.
What am I talking about? Regular MoneyWeek readers will probably be familiar with many of Japan's plus points.
For example, it has plenty of well-managed lean and mean companies. Overall, their profits are rising "“ total net earnings made by the country's publically quoted firms have more than doubled within the last fiscal year. Also a large slice of these profits comes from exports, so don't depend on Japan's ageing population.
"In fact, now that China is Japan's top trading partner", notes Hiroko Tabuchi in the New York Times, "Japanese export stocks seem a less risky way to invest indirectly in Chinese growth".
Yet current stock price levels in Japan "are saying there's no hope whatsoever for Japanese companies. That's simply not true", says Tony Roberts at Invesco Perpetual. "There are lots of great companies in Japan that add a lot of value."
Quite. What's more, many of these businesses offer great value to potential buyers. At the end of December, almost two-thirds of the 1,700 companies listed on the Tokyo exchange's main section had price-to-book ratios below one. In other words, if those companies were broken up and sold off, they'd fetch more than their stock market value.
Further, the Japanese market stacks up pretty well on other valuation measures too.
The wider Topix index now stands on almost the same price-to-earnings ratio "“ just under 16 "“ as the FTSE 100 and the S&P 500 indices, says Bloomberg data.
On another valuation measure, which compares the overall Topix market cap with the total sales of the companies in this index, Japan looks an even better bet. Its price/sales figure comes out at just over 0.5 "“ the lower the figure, the cheaper the market "“ as against 1.1 for the UK and 1.4 for the States.
All of which is compelling stuff. So what are the catalysts that could spark some serious Japanese share buying?
Ironically, the first "“ the near-term reason "“ stems from one of the burdens that Japanese companies have had to cope with in recent years "“ the strong yen. This has consistently hurt profits because it's pushed up the price of Japan's exports to foreign buyers.
Suddenly, though, a strong currency has become a good thing, for now at least. Japan imports almost all its oil and almost half its food needs. The cost of both is rising sharply in dollar terms.
The yen has climbed almost 30% against the dollar since July 2008, when crude reached almost $150/barrel. So compared with the last oil price spike, Japanese companies are now enjoying a much easier ride on import costs. The yen's strength is softening the blow to profits.
This would only be a short-term boost for the Japanese market. But when an investment class is as unpopular as this one, it won't take too much to get the buying ball rolling.
Then there's the second reason. Longer-term, those soaring oil and food prices are bound to push up inflation globally. This will cause worldwide bond values to drop as investors demand greater returns, ie higher yields, to compensate for their money being eroded.
We've written about this several times before, so I'll not repeat all the details. But to cut a long story short, history shows that the first sign of big global inflation problems is likely to show up in the US Treasury market, pushing up ten-year yields. In turn, that's set to be good news for Japanese stocks. Look at this chart.
Source: Bloomberg
The blue line shows the US ten-year bond yield. The red line indicates the relative performance of Japanese shares compared with equities across the rest of the world. Japan has "historically" outperformed 73% of the time US bond yields have risen, according to Jimmy Elliott and Yoshito Sakakibara at JPMorgan Chase.
Why? Almost uninterrupted falling prices "“ ie deflation "“ since 1994 have steadily eroded Japanese company profits. But looking forward, Japan "should in many respects be the biggest beneficiary among developed markets of a global pick-up in inflation", says Elliott.
A dose of domestic inflation now would boost Japan's company profits. Meanwhile the country's own bond market would suffer. The yen would likely stop rising as Japanese investors moved money abroad for higher returns. That would help Japan's exporters "“ and would switch even more attention onto how cheap their share prices now are.
The bottom line: if you want to invest in the stock market, Japan's looks just about the best bet around right now.
Of course, it's not quite that simple. If the yen drops you could lose out on the currency front. But my colleague Paul Amery has the answer for that "“ a currency hedged Japan ETF. And he explains how this works "“ and what you can do "“ here: When to use a currency-hedged ETF.
Or if you want a managed Japan fund, the Melchior Japan Advantage fund has just brought in a sterling-hedged share class that protects investors from currency moves.
When it comes to investing, size isn't everything "“ in fact, smaller firms regularly outperform large ones. The story's no different in emerging markets "“ and there are bargains to be had, says Cris Sholto Heaton.
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(28 February 2011, 11:41AM) Complain about this comment
This is difficult, I'm very interested in this as a lower/medium risk investment and love Japanese companies.However there's a real debate about whether interest rates in the UK will have to go up and thus strengthen the pound vs yen. Japan has been unable to raise rates for so long and it looks unlikely it will happen anytime soon so any strengthening around the world could really hurt this investment...couldn't it???
(28 February 2011, 12:23PM) Complain about this comment
And the dividends on Japanese stocks are ...
(28 February 2011, 01:15PM) Complain about this comment
Broadly agree with the article. However my biggest concern is the size of Japan's fiscal deficit and total government debt to GDP ratio. Sooner or later this will have to be addressed and my worry is that the corporate sector could be hit hard with higher taxes, thereby reducing profits at Japanese companies. Could this be why the market is being so cautious?
(28 February 2011, 01:27PM) Complain about this comment
Oh no, another buy Japan becasue Japan is cheap and "nothing lasts forever, does it ?" article. Since when was Japan ever a good investment for shareholders ? Since when did Japanese companies ever give a fig about the shareholder ? Answers on a postage stamp please. Japan is a rollacoaster ride. always has been, and always will be. Japan is getting masacred by its neighbours, and they're pulling away. Moneyweek need to get off this group think "Japan is the next long term Gold run" nonsense. It's complete tosh.
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