Japan: Bargain Basement Values in the 'America of Asia'
Today's Trivia Question:
Why should individuals do better than big institutions?

How soon we forget.

In the 80's, Japan was unstoppable. No industry was safe - electronics, motorcycles, automobiles, televisions, pianos - you name it; the Japanese were taking it over. And what they couldn't defeat, they bought. Sony bought CBS Records, Rockefeller Centre in New York was purchased by Mitsubishi Estate, and golf courses everywhere were snapped up by cash-rich Japanese companies. Japanese land prices soared to the point where a closet in Tokyo sold for the equivalent of hundreds of thousands of dollars. Clearly, Japan's Manifest Destiny was atop the world economic heap. Japanese stocks rose to bizarre heights, comparable only in silliness to NASDAQ of a few years ago.

During that era, I worked for a large Japanese stockbroker in London, England, servicing financial institutions - pension funds, insurance companies, etc. I remember reading about economic models that explained why Japanese stocks, although four times as expensive as the rest of the world, were actually…cheap! I dissected one such formula, and discovered that, if Japanese interest rates fell 1%, stocks would theoretically be worth precisely..infinity! (Give or take half an infinity, I guess!) With such weak underpinnings, it was clear that the Japanese market was due for a real collapse.

Little did I know how big that fall would be - over 80%! And even today, 15 years later, the Japanese market is still down over two thirds. Land prices collapsed, taking a good part of the banking system down with it. The economy went into a protracted slump. Government deficits soared to unheard-of levels. And what about those invincible Japanese companies? Well, they turned out to be remarkably vincible - vulnerable to new competition from South East Asia, Korea, Taiwan, and of course, China.

Today, while everyone is paying attention to China, India, income trusts, commodities, and currencies, the world's second-largest economy is largely ignored. In the meantime, however, quietly but steadily, the economy, and profits have begun to improve, even as stock prices remain cheap. Firms have closed factories, shifted production to China, and at the same time revamped exports to China itself. In fact, it is almost inevitable that Chinese growth will continue to pull Japan along with it. It's already happening. Japanese accounting is solid, and corruption is low. Firms with lots of cash, reasonable growth prospects, and great managements are selling for fractions of what comparable western companies fetch. The pendulum has swung completely in the opposite direction. And some very smart investors, such as Peter Cundill, fund manager extraordinaire, dubbed a 'Living Legend' by the Financial Times of London, began to take notice:

Could Japan at last be back? Over the past 12 months, the benchmark Nikkei 225 index has returned 32%, nearly twice as much as U.S. blue chips. And although its market has retreated over the past few weeks (as have stock markets around the world), Japan's economic fundamentals are still improving. Its trade with China is booming, and both corporate profits and consumer spending are getting stronger. The country's gross domestic product grew a surprising 5.6% annualized in the last quarter.

But the real attraction of Japan, says veteran fund manager Peter Cundill, is value. "The only market in the world that has a whole lot of cheap securities is Japan," he says. And when Cundill says something is cheap, he means seriously cheap. The 65-year-old native of Canada--he spends five months a year in London and the other seven in the U.S., Canada and Asia--is a devotee of Benjamin Graham's classic approach to stock valuation. Among other things, that means he sticks to companies trading for less than the shares would be worth if the firm were liquidated.

Japan is Still Cheap. Jonah Freedman, Money; July 2004, Vol. 33, Issue 7, p112A

What of the problems? The economy, and especially Japanese banks are still struggling from the bad debts of the bubble years. Government finances are poor. Companies are still restructuring. And then there's the population problem:

Most investors see the aging Japanese population as the nail in the coffin of an already beleaguered economy. Cundill sees great promise. "By the year 2025, 42% of Japan will be retired. The Japanese have three choices. They can reduce the pension benefits, but that is unlikely because 42% are a lot of voters. They can tax the young more heavily, but that is difficult because taxes in Japan are already quite high. The only other alternative is to generate a greater return on Japanese pension investments that are running at pitiful levels right now. If they can't up their returns, they are in really big trouble." The mother of innovation is necessity and the Japanese have plenty of that right now. The will is there but where is the way? That comes in two packets: one, Asia is changing greatly with the ascension of China into the WTO ranks, and two, old Japanese people will not be so good at making watches, but they are great marketers and have a culture well suited to being a conduit between China and the west. Cundill says dramatically, "you heard it here first. Japan is going to be the America of Asia." Japan's days as a maker of products are over, its days of moving and marketing them are just beginning.

Mutual Fund Review, Spring 2002

Here at Manulife Securities Incorporated, I can make direct purchases on the Japanese stock market of Japanese shares, particularly small companies, which to my mind offer the best value in the world. Individual investors have a great advantage over institutions in that they can purchase meaningful positions in small companies that offer tremendous value. Larger institutions aren't interested because they can't purchase enough shares to have any meaningful effect on their portfolio. A $500 million fund wanting to put 1% of its funds into a stock must invest $5 million. For a small company, that may be impossible. I also invest clients in Japan via funds, including Cundill's funds.

I'd be more than happy to further discuss the merits and possibility of Japanese investments for your specific financial situation. I have over 16 years experience in financial services, both in Canada, Singapore and London. Call me today for a free, no-obligation consultation. It will be well worth your time.

Sincerely,

Scott Swallow, HBA, MBA, CIM