Dow Jones Reprints: This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit www.djreprints.com
Bear markets usually end with a whimper, not a bang. No one on Wall Street fired a pistol in the air in 1932, or in 1982, to announce that shares had stopped falling. These were some of the most interesting investing opportunities in the history of the stock market. But hardly anyone was interested.
Or consider the great bear markets in commodities, and especially in gold, in the 1980s and 1990s. They all petered out miserably a little over a decade ago. Back then, you couldn't even start a conversation about gold. People's eyes would glaze over. They'd give a short, incredulous laugh if you brought it up, then change the subject.
I remember calling around London in 1999, trying to find any analyst who still covered the gold market. There were only a handful left. And none, it seemed, was remotely bullish -- not even with gold around $260 an ounce. One analyst thought it was headed below $100. It proved, in retrospect, the bargain of our lifetimes. But no one was interested. When the Bank of England sold off its bullion, it had some difficulty filling the orders.
There's a lesson in all this. Sure, you can make a profitable trade in the assets everyone else hates. But you make the really serious coin in this life by buying good assets everyone else has completely forgotten about, then sitting back and patiently waiting for the wheel to turn.
Does any market match that description today? Here's one that may: Japan.
Hold that thought! Hold it! The moment you read the word Japan, I'll bet your eyes glazed over. I'll bet you thought about flipping the page to see if there was something more interesting elsewhere in this month's issue -- on Greek bonds, maybe, or Apple. (Or gold?) You're not alone. No one wants to hear about Japan. Fund managers have lost money on Japanese shares every year they can remember, except 2005. Tokyo has been in a bear market for 20 years -- about as long as commodities were.
Many Japanese companies are sitting on significant piles of net cash. This can benefit investors in a few ways.
How are the mighty fallen! Twenty-two years ago, Japanese stocks accounted for nearly half the value of the world's stock markets. The land occupied by the Imperial Palace in Tokyo was valued more highly than all of California. The Japanese were conquering the world. No one could stand in their path.
Today, according to FactSet, Tokyo's share of global stock values is down to 7.5 percent, the smallest it's been in decades.
Yet Japan is still the world's third-biggest economy, and it is far more successful than most people realize. Japan is still a great exporter. It is running a current account surplus equal to 3 percent of gross domestic product (compared with America's current account deficit of 3 percent of GDP). Over the past 20 years, real output per worker in Japan has grown nearly as fast as that in the U.S. And while net government debt has rocketed to an unsustainable 130 percent of GDP, companies and households are in great financial shape.
Most important of all, the stock market is cheap. Possibly very cheap -- at a time when nearly everything else looks pricey. The Nikkei 225, Japan's major stock market index, trades at just 10 times forecast earnings. The dividend yield is up to 2.3 percent -- a hefty amount in a country with zero inflation. (Meanwhile, the 2 percent yield on Standard & Poor's 500 index is below the U.S. inflation rate.)
Japanese equities today trade for half of annual revenues, according to FactSet. (The figure for the U.S.: 1.2 times revenues.) And they trade for less than book value, while U.S. stocks trade for twice book.
A number of smart value managers, like Charles de Vaulx at International Value Advisers, note that many shares are even cheaper than they look. That's because so many Japanese companies are sitting on piles of cash they can use to shore themselves up if the economy gets rocky.
Take Mabuchi Motors, a midcap engineering company. Mabuchi makes the small motors you find in things like hair dryers, radio-controlled toy cars, seat recliners and power windows. What's the company's price tag? Mabuchi Motors' equity is valued at $1.6 billion. But the company has about $1.3 billion in net cash.
"There are literally hundreds of stocks like this in Japan," says Josh Strauss, comanager of the Appleseed mutual fund. "What this tells me is that you don't have a lot of downside risk." (Strauss has, however, hedged his fund's exposure to the yen, as he expects it to fall against the dollar.)
Japanese valuations are even impressing investment consultant Andrew Smithers, the famously skeptical author of Valuing Wall Street. Twelve years ago, Smithers successfully predicted the beginning of the long bear market in U.S. stocks. But he recently wrote to clients that Japanese equities "are absolutely as well as relatively good value." He suspects Japanese firms actually underreport their profits, because their accounting methods are particularly conservative.
The simplest way to invest in a potential Japanese bull market is through exchange-traded funds. The iShares MSCI Japan Index ETF (EWJ) is a low-cost fund, with management fees of 0.54 percent a year, that simply tracks the performance of the Nikkei. Studies show over and over again that in a rising market, a low-cost index fund will beat most "active" stock-picking fund managers. The SPDR Russell/Nomura Small Cap Japan ETF (JSC) is a vehicle for betting on smaller-company stocks. Money managers say Japanese small caps offer some of the best bargains. If a bull market takes off, you would typically expect them to beat their larger peers, albeit with more volatility.
What happens if the Nikkei booms but the yen tanks -- a distinct possibility, given Japan's huge public sector debts? Most dollar-based funds would give back some of the gains. But the WisdomTree Japan Hedged Equity ETF (DXJ) uses derivatives to hedge its yen dollar exposure, so you'll get pretty much the same return as someone in Japan.
Peter Bennett, a portfolio manager in London I know, is a fan of Japanese stocks. "The average fund manager," he says, "would rather suck a lemon than invest in Japan." I remember meeting Bennett for lunch in London 12 years ago. He made a similar argument then about gold.
Subscriber Tool
Track your own buys and sells
Ask the right questions before you hand over your money
A balanced portfolio can have a bigger impact on long-term performance than individual stock picking
Investing for retirement is more complicated than opening an IRA or maxing out your 401(k)
When choosing a stock mutual fund, consider performance, manager track record and cost before investing.
Even in times of interest rate uncertainty, a certificate of deposit (CD) can still be part of your cash strategy.
Find solutions to this and many other problems using
Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.
Read Full Article »