Active Investing in Japan

The Mainichi Shimbun (original in Japanese) reported early Thursday that Japanese Government Bonds’ (JGBs) popularity is rapidly falling among individual investors. Beginning in 2003, the Ministry of Finance (MoF) has sold two types of JGBs (a fixed-rate 5-year and a variable-rate 10-year) four times a year to individual investors. However, as interest rates have been held at zero (remember ZIRP) to near-zero levels for years, Japanese individual investors may finally be voting with their purses. The October 5-year issue had a coupon of 0.6%, the lowest since the program began in ‘03, and less than half the peak coupon rate of 1.5% in July ‘07.

The MoF now only expects to raise Y1.3 trillion (US$14.3B) this year from individual investors, down from a prior estimate of Y2.4 trillion, and considerably lower than the record Y7.2 trillion raised in ‘05. Through the end of this September, individual investors held Y27.7 trillion or 4.6% of JGBs outstanding. The MoF argues that recent individual investor reluctance for JGBs is not an issue because their weighting is so low. However, it goes without saying, as the article accurately points out, that it is an issue, as the government is poised to take on even more debt in the face of declining tax revenues.

In fact, the MoF is reportedly planning to introduce a fixed three-year JGB for individual investors next July. At this time, it’s hard to imagine a warm welcome, let alone a return to previous years’ embracing of JGBs. The MoF may be right in not being very worried, since it can just pressure domestic institutional investors to pick up the slack. So whether individual investors like it or not, it’s probably the case that they will remain proxy buyers of JGBs.

Japan watchers and investors will readily recognize and perhaps even sympathize with the plight of domestic savers. The golden days of the yen carry trade seem so distant with US$1/Y90-level support so sticky. It’s a real shame that Japanese companies don’t pay quarterly dividends as is common practice in the U.S., for instance, since household, quality Japanese companies are in some cases paying dividends at multiples of what JGBs offer. The desperate search for yield could be called off. Instead of chasing the latest overseas investment fad or making risky leveraged forex trades, maybe something more productive could be achieved.

Disclosure: The author has no direct exposure to JGBs, and does not believe a crisis is looming for Japan despite David Einhorn’s position, and in spite of the serious problems the country faces but continues to bundle into a bumbling status-quo. 

The latest and largest equity dilution — approx. $5.6B; 30% s/o — by Nomura (JP: 8604) (NMR: 5.63 +0.90%) has sent its shares down 16% to ¥573 in Tokyo ($6.35 at ¥90.3/$1) following an earlier rout in NY.  I think the stock has further to fall, given that it was saved by its daily loss-limit (‘limit-down’) in Tokyo with volume of only 8.9 million shares. Volume thus far in September has ranged from a low of 17M shares traded to start the month, to a high of 65M last Friday.

At this point, the $5.6B it plans to raise over the next month would have been more than enough to have just acquired Lehman USA last year! Now the company and its shareholders face the challenge and risk of having to use the capital to expand existing U.S. operations and somehow grow some new business. Doing these things (profitably) has never been easy for Nomura, though it’s always been a dream of sorts.

Meantime, the stock is massively diluted, and unattractive at current levels due to the uncertainty of how effectively it will deploy the capital — it’s about 40% above its March low. While I agree with Goldman’s take that the capital raising is offensive, rather than defensive, in nature, I think it’s a little much. The Japanese business press does too, apparently, dubbing Nomura and the broader market’s sell-off the “Nomura shock.”

- No position in any companies mentioned.

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.

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.

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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…

To say that the Japanese are sitting on a lot of cash is an understatement. In fact, with as much as $15T of aggregate “AUM,” they continue to struggle (esp. since the YCT was grounded) to find a way to earn better than next-to-nothing returns, given the nation’s miniaturized monetary policy. Individual investors’ long disregard for domestic equities (they’re not solely to blame) has been a big hindrance in bringing the benchmark Nikkei 225 back to a respectable level (20k remains elusive, but first things first, back to 10k). Don’t despair, however, because the Yamadas and Watanabes are back in action, rising through the wreckage — after the N225 nosedived in October to a 26-year low. 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…

The benchmark Nikkei 225 has gained 33% in the last six trading sessions since bottoming at a 26-year low at 7,162 on October 27. However, to put the surge in perspective: from the start of October to that bottom, the Nikkei shed an even more impressive 37%. So at a close yesterday of 9,521, the N225 is still nearly 2,000 points from its Oct. 1 close of 11,368, which as I’ve said many times before, is far, far from its 2007 peak levels exceeding 18,000. continue reading…

After four days of massive hemorrhaging (over 2,100 points lost), the Nikkei 225 bounced back in an afternoon session rally that gained momentum into the close. The N225 gained 6.4% (459 points) to close at 7,621. In early trading it wasn’t clear a positive close would happen — the N225 fell through 7,000 at one point to 6,884.90 (a 26-year low). The broader Topix-1 rose 5% to 784, hurt by heavier exposure to banks, non-bank financials and real estate. Nevertheless, the rally had breadth, as 79% of 1st section issues posted gains and 29 of 33 sectors were positive. A weaker yen was also a big help in at least temporarily relieving concerns of recent yen strength although its last trade against the dollar at 95 is still problematic for the “exporters.”

Heavy selling on Friday in Tokyo almost pushed the benchmark Nikkei 225 to its lowest post-bubble close (-9.6% to 7,649 vs. 7,607 set on April 28, 2003). And that’s not all: extended trading of N225 futures in Osaka brought a record session low of 7,100, representing another 520 points to the downside. Sony (JP: 6758) (SNE: 29.92 +2.96%) is said to have ignited the fire with its downward revised earnings forecast (no surprise really, since it’s no secret consumers are hurt and corporate forex projections are far out of whack). It was downhill from there, as deleveraging really took center stage, witnessed in a surge in the yen to a 13 year high and broad indiscriminate selling of equities.

The current levels for the Nikkei and other indices and the yen are unimaginable (the smart bet was for a N225 of 20K+ not <10K to be poised for new post-bubble lows). Worse yet (or better yet if you’ve got any cash left), valuations are far below what they were at the April 2003 trough. If memory serves me correctly, the former Merrill Japan strategist Jesper Koll had thrown out a target of 28K for the N225 by the time of the Beijing Olympics! continue reading…