The Nikkei, like many other benchmark indices, is hardly the volatile, motion sickness inducing headline producer that it was of months past. But no matter how hard I’ve tried, I just haven’t been able to turn myself into a green shoots market cheerleader. Nevertheless, I may be willing to concede that downside risk (in terms of a trading level) has lessened, although common sense would now suggest that significant further near-term upside is likely limited, too.

Now, on to the Nikkei 225’s valuation readings as of the end of May compared to a year ago’s levels.

• P/E ttm 05/08: 16.7 vs. 05/09: negative

• F/P/E 05/08: 17.1 vs. 05/09: 40.5

• PBV (book) 05/08: 1.68 vs 05/09: 1.24

• Dividend yield ttm 05/08: 1.4% vs. 05/09: 1.9%

• Dividend yield expected 05/08: 1.5% vs. 05/09: 1.6%

In case you’re wondering, the readings for Topix-1 suggest more “value” as the forward PE is at 35x, book value is 1.15x and the expected dividend yield is 1.8%. The benchmark 10-year JGB last had a yield of 1.49%.

If you are bullish, you would argue that Japanese stocks are still undervalued and you could even claim the bullishness of the old dividend yield indicator (vs. the JGB). On the other hand, the deep value of the N225 trading for less than book and with a dividend yield a full 100 basis points over the ten-year are history since the rally from the March bottom. The yen is interesting at 95 per US$1 because it’s near its reported break-even value for exporters, even though it’s 10% stronger than a year ago. While cost-cutting has clearly been helpful, the big boosts from forex profits are gone for now. Finally, Steel Partners continues to win ground against Aderans (JP: 8170), but the stock price is moving in the wrong direction. Who knows, maybe Warren will prove everyone wrong. I hope so. Meanwhile, it really is a comical game that most AIMs play in Japan.

For Japan, the 1990s are commonly referred to as the “lost decade.” Those that know me are aware that I look beyond that and actually regard a quarter-century as the appropriate “lost” duration. However, if one really thinks about what has transpired and where we are today, it is rather impressive that Japan continues to function in much the same way. Similar to Jesper Koll, who is now head of Tantallon Research, I find promise in Japan’s sustained, and comparatively large, investment in capex.

The problem for equity investors is one of procyclicality. And unfortunately, the global recession has displayed all the things that could go wrong and did (among them, the velocity of capital fleeing; widespread asset correlation; and the lack of sovereign unity towards a concerted acknowledgment and solution). Meanwhile, interestingly, Japanese companies keep plugging away, while both domestic and overseas consumers, and investors, alike, keep shying away. Unsurprisingly, I see no change in the procyclical behavior of people, whether in government, the markets, or among consumers. It almost seems like a catch-22 to be publicly traded.

In closing, as we rapidly approach the extended Golden Week holiday, let’s remember that the economic situation could be far worse than what it is. A decent chunk of companies will report earnings prior to GW, while a majority will be reporting after. The mood seems to be one of deflated expectations that go hand-in-hand with deflated results and outlooks. Although deflated does not mean dead, it means for the time being a misguided cap on the promise of what could come out of all the capex. The reality is that the best way to play Japan is either to be a trader, or to look for dividend yield supported by stable cash flows. In all likelihood, the Nikkei remains range bound: 7,000 at the bottom and 9,000 to the upside.

Pricey, and Japanese stocks, are typically not heard together in the same sentence. However, since last September’s market rout, earnings have deteriorated to the point that the Nikkei 225 is trading at over 175x forward earnings; 10.1x on a trailing basis. No doubt the ratio will swell some more, potentially going negative for a quarter, before it begins to ease. For some time now, I have believed that Japanese stocks are being priced fairly by the market. Still, it remains true that money managers the world over see deep value in Japan.

In order to prevent this article from getting long winded I will summarize my position as follows: (1) Recent trading has been ostensibly positive given the strong rally in percentage terms off the bottom, but the action has been quite thin; which leads me to point (2) in that the 9,000 level has proven pretty elusive due it being right about the middle point of last year’s finish and this year’s high (remember the N225 flirted with 6,000 a month ago); and (3) buying up headline exporters and bank stocks is the easy and obvious way to play, but lack of participation and depth in this rally will surely create a situation of more range bound trading between 7,000 and 9,000. Therefore, with all eyes on the U.S., and with the country’s financial magicians seemingly running out of rabbits, I would exercise caution at current levels. Aside from media cheerleading, last check the economic negatives far outweighed the positives.

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About a year ago today, I published a weekly Nikkei outlook discussing whether the Nikkei was headed to 13,000 or back to 12,000. Suffice to say that much has happened since then. At the start of the new fiscal year today, the range in question is broader, 7,000 - 9,000, but obviously it is not any better (unless one has profited on the short side or had a timely exit). At any rate, investors might be excited since March was a particularly good month for equities.

The Nikkei 225 gave back 500+ points in the last two sessions of March, but the usual claims of year-end window-dressing were audible, since the N225 still managed to gain more than 11% for the month — the ascent was upwards of 18% through last Friday. The 11.4% return tied 1999 for the best March performance since at least 1991. That’s history. So what can we expect for April?

The last two Aprils have produced gains of 9.4% (2008) and 2.2% (2007) for the Nikkei 225. Both of those followed losses of approximately 1% in March. The last positive March in 2006 (7%) was followed by a 2.5% decline in April. Of bigger concern is the fact that the ensuing April to December periods for each of the past three years have been rather brutal: -31% (2008), -11.5% (2007), and +1% (2006). For those looking for a trade or a glimmer of hope, note that the N225 has closed higher two-thirds of the time in April over the past 18 years. However, the first day of trading is no indicator for the remainder of the month since up/down days are split 50:50. Lastly, know that the average monthly gain for April in the past 18 years is 1.3% and the median gain is 2.2%. By the way, the 11% March performance in 1999 was followed by a gain of more than 2% in April.

My assessment of Japanese equities in light of the domestic and global economy is still primarily negative. I continue to be of the opinion that the current trading level of the N225 reflects fair value. A simple way to play may be to consider the low-7,000 level as an area of support and a buying point, and the approach to 9,000 as an area of resistance and thus a selling point. Remember that the N225 closed the year in 2008 at 8,859. The 52-week low was back in late October at 6,994, but most recently on March 10, the Nikkei flirted with the 6,000 level again when it closed at 7,054. Keep in mind that the N225 is now down only 10% for the calendar year thanks to the March rally.

While it goes without saying that stocks are a “leading indicator” and will recover before the broader economy, the best thing to do is to be realistic. No need whatsoever to rush into equities. There are too many lingering uncertainties and the potential for even more doom and gloom. With all eyes seemingly on the U.S. (after all we got everyone into this mess), don’t put much faith in the longer-term efficacy of tweaking mark-to-market valuation or public-private investment schemes that rely on the “goodwill” of banks. Too many ifs would have to be realized before a meaningful amount of confidence could be restored and sustained.

*This article may be reproduced only with the author’s prior consent.

The Japanese yen (JPY) is still “relatively” strong, but it has weakened by a pretty significant amount against the US$, nearly 10 points, in recent weeks. With much buzz of yen intervention leading up to the recent softness, one would have thought the MoF ran out of patience and intervened. Well, in fact, it kind of did in a sense, since the now disgraced former Finance Minister Nakagawa couldn’t handle his glass at the G20; and the latest Japanese political news scandal involves a case of potential campaign contribution fraud by the opposition party — maybe now is the JCP’s chance. So, with Japan so concerned about “reputation risk,” one would assume a national policy would call for carefully cultivating it. However, in addition to the above, the musical chairs of inept prime ministers post-Koizumi and the ceaseless political gaffes, have instead resulted in carelessly damaging Japan’s reputation. Should the yen find relative strength again — and it just might considering the basket case of currencies out there — unless there are more snafus within the GoJ, then I continue to believe there should be no deliberate intervention since it would still be premature at this point given deteriorating global economies.

Yen ETFs traded in the U.S.:

CurrencyShares Japanese Yen Trust (FXY: 103.72 +0.77%)
Ultra Yen ProShares (YCL: 24.95 +1.56%)
UltraShort Yen ProShares (YCS: 23.27 -1.48%)

Former Japanese Finance Minister Nakagawa should never have been at the press conference that did in his career, and now has the Japanese press gone mad discussing “reputation risk.” It is disturbing that he was even allowed near the table. Equally troubling is how BoJ Governor Shirakawa didn’t preempt some questions, especially the one’s directed at him. Instead of fielding questions, he bobbled, and quite frankly, made himself look ridiculous by association. I would go as far to say that if the Japanese are so concerned about “reputation risk” that the journalists should have done the right thing and helped Nakagawa exit stage right, immediately, after becoming aware of his condition. They could have exposed him on the side or in back, instead of in front of the world.

As for Japanese stocks: I still believe that as a whole, Japanese stocks are being priced fairly by the market. Readers may have noticed how we are now rather quietly approaching last year’s low levels, which are effectively near the post-bubble trough and quarter-century ago levels. Japan may have been first into recession, but it is almost certain not to be first out — in fact, aside from the late-05 to early-07 period, Japan had basically never really exited. The current administration’s proposed economic stimulus for Japan is insignificant and deficient; and a recovery still depends more on a rebound in consumption in the US and EU, something not likely to happen soon enough or meaningful enough. Therefore, I don’t think there is any urgency for intervention to soften the yen. It would be premature. In addition, I see no rush to buy for instance, iShares MSCI Japan Index ETF (EWJ: 9.33 -2.20%). The worst case scenario is the status quo of depressed equities and relative yen strength, a double whammy.

The author’s intent is not to be misleading, but rather to be as frank as possible, regarding the longstanding debate of whether or not Japanese stocks are truly undervalued. In short, the answer is  no. I no longer believe Japanese stocks are undervalued, not to the extent that I once did, and not to the lengths that some pundits and money managers try to make a case for. In fact, I would argue that Japanese stocks may best be described as being closer to fair value instead of being deeply undervalued. I mean Japanese stocks, for the foreseeable future, may be destined to be “undervalued” by traditional metrics, but fairly valued by the market and in relation to the economy. [Read more →]

No surprise that the BoJ kept rates unchanged at 0.1%. That a return to deflation is expected comes as no surprise either, since in reality, deflation never really ended, even when commodities surged last year. Meanwhile, the Japanese are left in the same predicament, with next-to-zero returns on deposits and no real need or desire to consume beyond necessities. Unenviable circumstances for both individuals and businesses, alike.

The “borderless conventional banking stupidity failure” refers to the clipped text below. With exports plunging and domestic demand continually depressed, it’s unnecessary to obsessively cater to the big players idling plants and curbing expansion. Rather it’s of utmost importance to ensure that lending not only continues, but does so without excessive stringency, at the SME and individual level, in order to have any hope of minimizing the effects of prolonged deterioration of the economy. This is a simplified argument, but the crux of the problem, especially in Japan (or I could say “even in Japan” despite all the cash held by companies and individuals — innate risk aversion exacerbates the problem). And again, a truly unenviable situation (regarding the lending climate), but in this case, one not so different than what we are witnessing, say for instance in the U.S.

clipped from www.marketwatch.com BoJ holds rates unchanged; sees deflation ahead The BoJ’s quarterly survey of bank-lending practices, released on Thursday, showed large financial institutions lowered lending standards for large firms, kept them unchanged for medium-sized firms and tightened them for small firms and households.

I don’t agree with the BoJ’s decision to cut from 0.3% –> 0.1%. The cost of borrowing is not the problem here. In fact, the impetus to cut was at least partially pressure from the MoF, in what amounts to a silly attempt to ease yen-strength. The reaction has been muted, and for now, the USD/JPY isn’t likely to even recover a 90-handle. [Read more →]

No need to get excited over the fact that the Japanese economy has now contracted two consecutive quarters (no shooting the messenger). That was largely already factored into equities, thus explaining the severely depressed levels registered of late. However, as The Economist reported in its latest edition, the “Toyota shock” of a sharp decline in expected earnings (-74% fiscal y-o-y) reverberated across Japan, bringing home the realization, to some, that stocks may not be so cheap anymore. So, it may be the case that we are closer to fair value, in spite of a market that pretty much trades at book value. [Read more →]