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.
Looking at earnings, we see that on trailing basis, stocks trade at just under 11x, whereas on a forward basis, they’re closer to 15x (as of 11/14 close per the Nikkei). The problem is that while there were some economists who thought Japan could avoid a recession, economists now point to the carnage in equity markets in October (and the subsequent job losses announced across the U.S. and EU, in addition to a likely further decline in capital spending) and fear the worst has yet to come. After gapping down Monday, Japanese stocks managed to close in positive territory on rather light volume/turnover, a trend of late (N225 +0.7% and TOPIX +0.4%), although respective futures settlements are more telling at +0.1% and -0.5%.
Where do we stand? Up over 20% from the 26-year lows of red October, but in continually deteriorating conditions, the bearish case appears to get the nod. The Economist is dead-on when it states the obvious concerning valuations and also in its conclusion that what Japan needs long-term remains the same … but don’t expect much other than complete coupling to the world economy. Liken the still many enticing valuations to a modern adaptation of Hemingway’s The Old Man and the Sea, with the setting captured in chiaroscuro. If you happen to be long the market, be hopeful that pension funds remain your friend and in the very least, that defensive stocks hold up.