Twenty years ago, John-Paul Temperley was an intern in the SBC Warburg office in Tokyo. I was a junior broker, flogging Japanese equities to institutional investors across Asia. Until a few months ago, I hadn’t seen him since. However, he is now frightfully senior at Martin Currie; co-runs a fund that invests in Japan; and has an office 20 minutes walk from my house. I thought that I had better exploit the contact and pop over to see if he is as bullish on Japan as the rest of us. He is.
Japan, he says, is both “cheap and under-owned”. It’s cheap in the sense that 80%-90% of the listed firms trade at a price well below their book value (the market value of their assets). Theoretically, you could buy them, shut down their businesses, sell off their assets and walk away with a pile of cash. In some cases you might not even have to bother selling anything: much of the book value of Japanese companies is already made up of cash. He also notes that, contrary to the general view that there isn’t much going on in Japan, its economy is still creating enormous value. Japan “still registers more patents every year than any other developed economy, so there is still a lot of intellectual property” being created.
Add it all up and you’ve got a lot of cheap, well-capitalised, “emerging-market-facing companies with excellent intellectual property”. I ask about the trouble at Olympus – where the board of directors spent ten years and ¥135bn covering up investment losses in an astonishing example of bad corporate governance. Does this scandal tell us bad things about the dangers of investing in corporate Japan as a whole? Or is it a one-off? It probably isn’t a one-off, says John-Paul, but in general Japanese management is “okay”. And you can’t pull out of a country’s market just because of one nasty. “If you’d sold all your US stock holdings because of Enron, you’d have missed a nice bit of the market.” It’s a good point.
John-Paul also reckons that the political paralysis that’s been holding Japan back for so long is closer and closer to being resolved. “I tell clients that the most encouraging thing that has happened in Japan in the last three years has been the changes in government.” We’ve had six prime ministers in five years. That tells you that “democracy is alive in Japan”, that people are “dissatisfied with the status quo” and they want something done about it. This matters in Japan: for 50-odd years there has been no real change in politics, but now there is just about enough protest around to think that there might soon be some.
How to cope with the yen
Ok, I say. But if things are so great in Japan, why has the market performed so horribly (the Nikkei 225 is down 11% in yen terms this year)? The “bloody currency”, says John-Paul. The correlation between the performance of Japan’s stockmarket and that of its currency is absolute – when the yen goes up, the market goes down. And the yen has been going up for a long time. The silver lining to this is that anyone based in Britain who has followed our suggestion of investing in Japan has done fine – the rise in the currency has offset the fall in the market. The same goes for those who have invested on an unhedged basis with John-Paul.
When will it end? When the other big economies stop with the monetary easing; when Federal Reserve chief Ben Bernanke “announces on prime-time TV that QE3 [quantitative easing], QE10 or QE-whatever is being cancelled because the economy is improving”. That would push the yen down instantly (it’s currently being used as a safe-haven currency) and the market up, making it the ideal time to “buy as much as you can of hedged yen assets”.
However, as that time isn’t now, you are probably better off with the “less risky trade” of holding unhedged yen assets. That way, while you are taking downside risk on the currency, you aren’t taking as much risk overall. If the worst happens and the dollar utterly collapses against the yen, your stockmarket losses will be lessened by the strong currency. And if the best happens – the global economy gets sorted and the yen falls – what you will lose on the currency you will make up several times over on the market.
Will Europe turn Japanese?
That seems pretty clear and tallies nicely with our own views (always reassuring). So we move on. Does he think that Europe is on the verge of becoming the new Japan? In the sense that Europe is seeing “deflationary pressure caused by a de-risking bank system and a structural lack of demand for credit”, yes, he does. However, there are major differences between the situation in Europe now and that of Japan in the 1990s.
First, the sovereign debt. In Japan it was (and still is) mainly domestically funded. Thanks to the fact that it was one of the few places for the banks to “find a home for their deposits”, there was always strong underlying demand for government debt. The debt-to-GDP ratio may have been vast (and still is), but as long as people are prepared to refinance you, that doesn’t matter. In Japan, despite 15-odd years of scaremongering on the subject, financing still isn’t a problem.
The second difference, of course, is that Japan never had negative real interest rates. In the West right now, you can’t get an interest rate on a deposit that covers inflation and tax: returns on deposits are negative in real terms. But in Japan, flat prices and occasional actual deflation meant that even very low interest rates on deposits and yields on government bonds (JGBs) were positive in real terms. That made it, and still makes it, “absolutely logical” to invest in deposits and in bonds over equities.
That’s not the case in the West, where keeping money in cash means losing purchasing power everyday (unless you are saving up for a house, of course, in which case each pound buys more most days). All this means there is more domestic support for European markets than there ever was for Japanese markets.
I ask him what he would do if he were in charge in Europe. Like the rest of us he doesn’t have much idea: “the only thing you can do is restore confidence”. He and his colleagues reckon that Germany will in the end allow the European Central Bank (ECB) to monetise as much debt as is needed. First, Germany will want to be clear on the need for fiscal union as the trade off, but once that price is exacted there is bound to be monetisation via QE.
Buy Japanese real estate
So would he buy European stocks as a private investor on that basis? He might. Equity markets have already discounted recession and bad earnings numbers. “Valuations are generally low”, and so many people have been selling down holdings that, “even if there is an Armageddon-type event, the market has kind of discounted it”.
The bad news is in the public domain – people are talking about the European debt crisis at dinner parties in the same way they talked about dotcom stocks in the late 1990s. When “it feels uncomfortable” to buy, that often turns out to be the best time to buy. But it’s also worth pointing out that even during the first 15 years of Japan’s ongoing deleveraging, “you still had three or four decent economic cycles”. The cycles were short because they were reliant on inventory restocking, but they were still good bounces – and they came with good stockmarket bounces too.
Overall, he thinks equities look cheap, which is nice. But as everyone who has ever worked in Japan knows, “that doesn’t mean they can’t get cheaper”. It doesn’t mean we should all move all of our money out of cash and into stocks.
I ask for a stock tip – his favourite Japanese share at the moment. Fund managers hate being pinned down like this. But John-Paul is good enough to offer a suggestion. “We like real estate in Japan,” he says. Since the earthquake there has been a big increase in enquiries for new offices, yet there is “very limited supply” for the next four or five years.
As long as Japan’s economy continues to “tick over at a moderate pace”, the supply and demand balance should “improve dramatically”. How do we buy real estate in Japan? I ask. “Mitsubishi Estate,” he says – the ticker is JP: 8802. So there you have it – for the first time in many months of interviews, a stock tip.
Who is John-Paul Temperley?
John-Paul Temperley is co-manager of the Martin Currie Japan Alpha Fund (along with Keith Donaldson and Claire Marwick) and the Japan Absolute Alpha fund, which uses a long/short strategy to play the Japanese market. The Japan Alpha fund has consistently outperformed its peer group since its launch in 2006, returning 0.1% over five years compared to an average loss of 11.5% for the sector, as measured by the Investment Management Association. Over three years, the fund is up 25.9% compared to a sector average of 13.6%. Temperley is also an analyst, covering the Japanese transportation and auto sectors.
Temperley joined Martin Currie in 1998. Before then, he worked on SBC Warburg’s Japanese equities desks in both Tokyo and London. He graduated from the University of Leeds with a degree in Chinese and Japanese studies. He is fluent in both Japanese and Mandarin Chinese.