Why investors can’t afford to ignore Japanese stocks
Earlier this year, it appeared that Japan was indeed experiencing a very good pandemic. The number of cases had been low. The total number of deaths was less than 2,000, in a country with a population twice that of ours. In April, Prime Minister Shinzo Abe announced that it was the result of Japanese exceptionalism – the result of doing things in a “quintessentially Japanese way”. His deputy went a step further. The success, he said, was about Japan spirit (a not very easily translatable term which refers to the quality of a group of people) being at the top.
Other suggestions centered on the very low level of comorbidities in Japan – very little obesity and therefore very few type 2 diabetics, for example; the fact that Japanese people rarely entertain in their own homes (most interactions take place in bars and restaurants outside the home); the existence of local health centers originally created to track and trace TB patients; the cultural traditions that make the Japanese rarely touch each other; and finally the prevalence of the vaccine against tuberculosis, which is thought to confer some sort of immunity.
The problem? It turns out that exceptionalism is less common than you might think. Cases are now increasing in Japan. Its first two waves were bumps on the chart, but it is now recording a seven-day moving average of over 3,000 cases per day, as deaths approach 3,000. This is a dismal example (albeit s’ it should be noted that, like most countries in East Asia, Japan is still faring much better than any country in the West).
But maybe this should serve as a reminder that while a lot about Japan is different and interesting, it is not, as newly retired Japanese strategist Jonathan Allum puts it, “uniquely unique” (listen to our podcast on moneyweek. com for more information from Allum). This, says Allum, is something more investors should recognize. Too much jostling Japanese stocks, or if they don’t ignore them completely, they consider stock selection in Japan “problematic” and “index their Japanese portfolios while actively managing the rest of the world”.
Market breadth is unmatched outside of the United States
The first of these things is certainly wrong – and the second probably is too. The Japanese stock market is “unmatched in size outside the United States”. It is home to some of the most important companies in the world. And its stock of listed companies “is replenished by more than 80 initial public offerings (IPOs) each year” – at a time when many Western exchanges are contracting. He has an increasingly pro-shareholder bias after many years in which you might have suggested that he was pushing the idea of stakeholder capitalism to an unfortunate extreme.
Its corporate relationships are no longer impenetrable and its largest companies “employ skillful investor relations services” and (at least before Covid-19) travel the world to meet with foreign investors. There is more good news. His businesses are in very good shape. Peter Tasker of Arcus Investment points out that of the few companies in the world that are over 200 years old, 55% are in Japan. They must, he says, “do something right” (to learn more about Peter, go to moneyweek.com and listen to our podcast with him). There is no way that those who are not could have survived the last 30 years. The deflationary environment in place since the crash of 1989 has forced the corporate world to maintain continued profitability and sparked a penchant for cash that is not seen anywhere else. If the buzzword in post-pandemic investing is to be “resilience,” Japan should be the market everyone is heading to.
Its listed companies entered this crisis with the largest reserves of liquidity on record: around $ 6.5 billion in cash and short-term securities on their balance sheets, explains Jesper Koll, advisor to Wisdom Tree Investments, in the Financial Times. This constituted a “war chest” worth about 130% of GDP and well distributed in the market: in May, 54% of Japanese companies had cash flow greater than their equity. In the United States, the ratio is less than a third of that, and the available money is stuck in the already too full pockets of big tech companies.
It matters. Japan’s money provides a buffer against the continuing catastrophes that seem to make up the modern world and could mean that there is a wave of mergers and acquisitions ahead. This is something that is generally good for markets, especially those as fragmented as that of Japan. Be on the lookout for activities in the auto parts, insurance, chemicals and base metals industries, says Koll. But it also means that Japan can guarantee investors what they really want: income.
The payout ratio has long been quite low (up to 35% of net profits). But it is skyrocketing and now hovering around 60%, thanks to both rising dividends and share buybacks, very rare in Japan until five years ago. Buybacks have declined slightly this year amid uncertainty, but the overall market is posting a dividend yield of around 2.5%. Add in the expected buyout next year, Tasker says, and you’re looking at a total dividend and a buyout yield of around 4%. What kind of idiot would ignore this in a world of negative interest rates?
A game adapted to global growth
There are two other reasons to invest in the Japanese market in general. The first is that, as many of those who invest in it passively believe, it often moves with the global economy. Global growth up, Nikkei 225 up. This makes sense, given how outward looking this market is.
It’s not just because it’s the world’s third-largest economy (and a great example of how a small island can handle a massive economy without ceding sovereignty to a giant neighbor). It’s also because the market has considerably higher exposure to cyclical sectors such as vehicles and financials than most, while large Japanese companies have their fingers in the pies of many other countries as well. Sales of affiliates abroad represent about 60% of GDP, according to Tasker.
An example: Fast Retailing (owner of Uniqlo) may seem to have a store on every street corner in Tokyo, but it still generates more sales and profits in China than in Japan. Point? If the global economy picks up sharply next year (as the vaccine leads to normalization of activity), the Japanese stock market will as well. Japanese analysts tend to be cautious about forecasting, notes Nikko Asset Management, and company executives “on which sell-side analysts rely a lot, can get into legal trouble if they steer earnings in such a way. too optimistic “. So if the global economy surprises on the upside as pent-up demand after the lockdown is unleashed, as we believe, then Japanese corporate profits should surprise on the upside as well.
In the basement of good deals
The next reason international investors are giving up their relentless denigration of Japan is valuations. Even before the profit surge you might expect in 2021, Japan is remarkably cheap. There is the yield mentioned above. But beyond that, Tasker says, price-to-earnings (p / e) ratios are still at levels “I’ve rarely seen in my long enough career.” There has been a sharp increase in the Nikkei since 2012, but the average price / pound (p / b) in the market has barely budged.
This tells you that the momentum was not about increasing multiples, but increasing profits. Japan is now trading on a cyclically adjusted (Cape) p / e ratio of round 19, against a historical average of 23 (US figures are 30 and 25 respectively) and a p / b ratio of 1.3 (close to its historical average). There, says Tasker, are valuable opportunities of “an extreme nature.”
All of this sounds good – and could explain why Japan is already in the middle of a stealthy bull market. The Nikkei rose 15% in November alone and is now flirting with 27,000. This is a far cry from its high of 38,915 in 1989 (it fell 40% in 1990 and 26% in 1992), but nonetheless represents a fairly splendid recovery from the lows of 2011, when it hit 8,295. In fact, say Gavekal analysts, if you eliminate consistently underperforming financials, Japan’s equity markets have had a “very honorable last decade.”
The Daiwa All Listed Non Financials index has risen by more than 70% since 2010. There are risks in Japan as everywhere else (no more Covid-19 nightmares, currency fluctuations, too much debt, etc.), but in most areas. what matters to investors looks good. In 2021, Gavekal says, it will thrive, just “unbeknownst to most investors.”
What to buy now
So if Japan is going to prosper, how can your portfolio prosper alongside it? How about watching what Warren Buffett’s up to? In August, he invested $ 6 billion (in real money) in five of the biggest sogo shosha, one-off commodity trading companies which, as the FT puts it, “are increasingly turning into global venture capital and private equity firms.” Berkshire Hathaway is now a major shareholder (over 5%) of Mitsubishi Corp. (Tokyo: 8058), Mitsui & Co. (Tokyo: 8031), Sumitomo Corp. (Tokyo: 8053), Marubeni Corp. (Tokyo: 8002) and Itochu Corp. (Tokyo: 8001). It all makes perfect sense. They are hedges against inflation and heavily dependent on global growth, but also cheap and plugged into the success of the national economy – including unlisted companies where much of the growth is to be found. They should benefit from the cyclical reopening of trade. Otherwise the Baillie Gifford Japan Trust (LSE: BGFD) is a great way to get general exposure to Japanese growth.
The Lindsell Train Japanese Equity Fund offers a more focused portfolio of high quality companies; the Baillie Gifford Shin Nippon trust (LSE: BGS) gets you into smaller growth companies (I’m on the board of this trust, so don’t take that as a recommendation!). Income seekers should consider the JP Morgan Japan Small Cap Growth and Income Trust (LSE: JSGI) and the CC Japan Income and Growth Trust (LSE: CCJI).
Those who care about value (as we all should be!) AVI Japan Opportunity Trust (LSE: AJOT), which seeks to take advantage of changing corporate governance trends in Japan, and Man GLG Japan CoreAlpha Fund. The latter had a disappointing 2020. But if the global rotation from growth to value investing accelerates, it could have a better 2