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.
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.
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.
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.
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.
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.
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.
What to watch: Monday and Tuesday, May 5-6: Nothing — TSE closed (trading resumes Wednesday); Earnings season also resumes; Friday, May 9: Index of Business Conditions (Cabinet Office)
Ongoing: As always, external factors will impact domestic equities; however at present, conditions seem favorable given the weakening yen (now around ¥105/$1) and an accommodative Fed on all fronts. Concurrently, that the Japanese government is protectionist or that the Bank of Japan is helpless seems to be beside the point. Meantime, the ongoing question is whether Japanese stocks represent true value or instead, if the apparent value is merely an unobtainable mirage for gaijin investors.
What to watch: Earnings reporting continues; JGB activity (unprecedented サーキットブレーカー (circuit breaker) action last Friday; rising yields but equity yields still attractive to the 10-year); Tues./Wed., April 29 -30: FOMC rate decision meeting; Wed., April 30: Bank of Japan (BoJ) monetary policy meeting; March – Industrial production; March – New housing starts; March – Unemployment and Ratio of Job Offers to Applicants; March – Household income and expenditure survey; U.S. Q1 GDP; Thurs., May 1: April – New auto sales; Fri., May 2: U.S. April – Unemployment and U.S. nonfarm payrolls
Ongoing: External factors, particularly U.S. earnings and economic data (see above) to influence domestic stocks; record commodities vs. weakening yen [¥104.5/$1 on Friday]
What to watch: Key earnings reports begin Wednesday 4/23; Friday 4/25: CPI for March (April for select metropolitan areas)
Ongoing: External factors will inevitably weigh on domestic stocks (bullishness in the U.S. helped pull the Nikkei up to a multi-week high by week’s end).