Active Investing in Japan

Reuters (article in Japanese) reports that Goldman Sachs issued a report earlier this week that argues M&A will be the major theme for Japanese equities in 2010. Having a ‘macro’ investment theme for the start of each new year is a ritual for brokerages in Japan, although it seems no one ever has the resolve to action or follow through; and the M&A theme itself is not a new one. So Goldman repeats known information that Japan (equities) was overly victimized in the financial crisis and remains largely defenseless to external shocks. With ROE so low, domestic demand remaining sluggish, and overseas competition ever-intensifying, the best bet for Japanese companies is to merge and restructure. M&A/restructuring should boost top-line growth, says Goldman, which also should help margins, and therefore drive stock prices higher.

However, the longstanding problem with inward M&A is that reorganization is easier said than done (as heads, and tails in the form of non-core subsidiaries, tend not to roll in Japan), the volume of M&A has often disappointed, and the size of deals has been on the small side.  Nevertheless, all of that means there is still great opportunity in Japan. The best opportunities appear to continue to be in smaller-sized deals, where there are plenty of gems, and in listed subsidiaries. Goldman is said to favor retail, machinery, services, land transport, non-bank financials, warehousing, and real estate — the underlying idea is that these industries are the most fragmented.

Bottoms-up then, as 2009 is winding down and 2010 is poised to be the year of M&A (at least thematically or in a macro sense).

More often than not, it is overseas factors that have the largest influence on trading in Japan. However, from time to time there is enough commotion domestically that also warrants the attention of investors. Unfortunately, the cacophony coming out of the government these days is more concerning than usual (e.g. Japan Post management/reform, debt moratorium, JAL, etc). But let’s not forget earnings season is here.

Following is a market summary of last week’s action courtesy of the Tokyo Stock Exchange:

Despite the decline in the American exchanges reflecting weak corporate financial statements, the market continued with slight gains from the previous week backed by the strong tone of the Asian stock market. Further into the week, rising prices of oil and other commodities in the commodities market led to buying centered around resource stocks as the market strenghtened. Heading into the weekend, while there were positives with the yen falling to the 91 yen-per-dollar level, easing concerns over deterioration in corporate export estimates, many uncertainties such as the reconstruction of JAL and the direction on the moratorium remained. In addition, a wait-and-see sentiment grew amongst investors as they chose to wait for the announcement of July-September period financial statements by domestic corporations. As a result, the market struggled to make any headway.

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.

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

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. continue reading…

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. continue reading…

Prior to yesterday’s 6.5% drop in Tokyo (Nikkei 225 close at 8,899), the N225 had rallied 33% in the prior six sessions to recoup a good chunk of the 37% drop between Oct. 1 and the 26-year low reached Oct. 27 at 7,162. Yesterday I stated the obvious in that Tokyo would sell-off as reality set in post-Obama euphoria, but I made the point that the number of sellers would be limited. In fact, volume and turnover weren’t exactly heavy, although stocks were broadly lower. continue reading…

Japanese stocks “rallied” a spectacular 14% last Tuesday, but in spite of that (and being surrounded by massive days of selling), I lacked the broader market’s bullish conviction and explained why in “Trying not to rain on the Tokyo stock parade.” Overnight, the Nikkei sold-off about 6.8% to fall back below 9,000 again to 8,674, erasing the gains from a three-day rally. During that period there was a spooky appearance of bullish stories on Japan, particularly advocating banks. In fact, it is a recurring theme: whenever there’s page space to be filled, a couple days of higher closes in Tokyo, or the desire to sound smart and talk about valuations. Unfortunately, it is easy to be misinformed and fooled. continue reading…

In a report issued today and covered by Reuters (see below for clip and link to Japanese original), Goldman Sachs says it sees a possible full recovery for Japanese stocks from mid-2009. On one hand, GS warns that a further slowdown in the global economy represents further downside risk for Japanese stocks given the nation’s high reliance on exports. On the other hand, corporate profits are seen recovering from late 2009 with fiscal year 2010 profits back to positive y-o-y growth. For FY March ‘09, GS now forecasts profits to fall 12.0%, compared to 10.2% previously. For FY ‘10, GS sees profits up 6.0%, but that’s less than the 12.5% it previously estimated.

GS is not alone in its earlier assessments of Japan, noting the nation’s comparatively better ability to cope with high oil prices; however, the fact remains that Japan still imports a significant volume of oil to support its energy producing needs. In addition, GS has previously cited the attractive valuation of Japanese stocks, with some 60% or so trading below book value and dividend yields of 1.9% exceeding the 10-year JGB of 1.5%. Although it’s true that Japanese stocks have outperformed in recent months, it’s also true that Japanese stocks are down around 25% across the board since a year ago. Stocks are down even more compared to recent years’ highs, which never touched 20,000, in the case of the N225.

So, while the perception of attractive value exists in Japan, the reality of realizing or unlocking this value remains elusive.

clipped from jp.reuters.com 日本株、本格的な上昇は09年中盤以降の可能性＝ＧＳ証券

What to watch: Monday and Tuesday, May 19-20: Bank of Japan [BoJ] Monetary Policy Meeting; Tuesday, May 20: Monthly Report of (May) Economic and Financial Developments [BoJ]

Ongoing: Earnings season is in the home stretch; 150 announcements are scheduled for Friday (less than 50 are scheduled for the week of May 26); It goes without saying that external factors will continue to impact domestic stocks, however record oil and yen hovering around the ¥105 level have not stopped the Nikkei’s recovery of 14,000. continue reading…

What to watch: Earnings season peaks with over 1,700 companies reporting this week; Monday, 5/12: Economy Watchers Survey – March (Cabinet Office); Money supply data – April (Bank of Japan (BOJ)); Wednesday, 5/14: Corporate Goods Price Index – April (BOJ); U.S. CPI – April; Thursday, 5/14: Machinery Orders – March (Cabinet Office); Mansion/Condominium sales – April (Real Estate Economic Institute Co.); Friday, 5/16: GDP – January to March quarter (Cabinet Office)

Ongoing: Earnings, earnings, earnings! And as always, external factors will impact domestic equities, most noticeably rising commodities (record oil) and a weaker dollar (stronger yen): ¥102.80 on Friday vs. ¥105.4 the prior Friday. continue reading…