I started suggesting that investors buy into Japan in early 2004. Nothing happened for a while, but at the end of that year it started to look like a brilliant call. Having gone nowhere for years the market’s benchmark index, the Nikkei 225, promptly pulled itself together, rising more than 50% in the next year.
The world’s fund managers were delighted; money poured in; business-class seats to Narita filled up; and old friends from my Tokyo stockbroking days launched hedge funds and bought houses in Notting Hill (you make money fast when prices are rising a few per cent a day and you get to keep 20% of everyone’s profits).
Then things went a bit wrong. In May last year the market took a tumble, at one point falling more than 13% from its January levels. Things righted themselves by the end of the year, but the Nikkei closed only 5% up on the year. This year hasn’t been much more exciting: had you invested in January you would have made 1.36% by now.
We could be generous (to me) and annualise the total returns to show that if you invested in late 2004 or early 2005 you’d still be sitting on annualised gains of just over 20% a year. Put it like that and it doesn’t sound bad, but the truth is that, in terms of even preserving the purchasing power of your cash, the Japanese market has been worse than useless for the past year and a half.
So, do I keep holding or do I give it up? I’m going to keep holding. Japan features heavily in my self-invested personal pension (SIPP) and will continue to do so. Here’s why.
Today’s investors are desperate to find safe havens as they see that the economic cycle has not been cancelled, that the sub-prime problem has not been contained, and that the US is seriously at risk of recession.
Most of the investing world appears to think Asia fits that bill. That’s why net inflows into emerging-market equity funds hit an 85-week high in late September, according to EPFR Global, and that’s also why the MSCI Emerging Markets index has outpaced all developed markets and gained about 13% in dollar terms over the past three months to hit a new high.
But is emerging Asia really that safe? I wouldn’t be too sure. Asian stocks now trade at a premium to developed market stocks, something that only makes sense if you believe in the decoupling theory – that emerging Asia has developed to the extent that it can continue to churn out impressive growth regardless of what happens to the US. I don’t buy this.
However you cut the numbers, most of Asia is dependent on exports to fuel growth, and, in particular, exports bought by overextended US consumers.
In a decade, I can’t imagine that investors in Asia will give the US a second thought when making their decisions, but we aren’t there yet. Right now I wouldn’t call emerging Asia a safe haven. I’d call it a bet on an unproven theory, a speculative investment, and I’m not betting my pension on it.
Japan, on the other hand, might turn out to be a truly defensive place to be. It is one of the world’s biggest and most liquid stock markets (something not to be underestimated in times of trouble) and it includes some of the best companies. Think Nintendo (7974), which is well managed, makes things all teenagers (and most grown men) want and is growing its profits at double-digit rates. Or Toyota (7203), which is not only the world’s largest car-maker but also already dominates the green-car sector.
Better still, Japanese banks have little exposure to sub-prime and the market as a whole is looking relatively cheap – trading on a forward price/earnings ratio of about 16 times. This is much the same as the levels in most developed markets, but Japanese bulls point out that the difference in Japan is the fact that interest rates are so low.
As Jonathan Allum of Belgian bank KBC, who is cautiously keen on Japan, explains, equities have to compete with cash and bonds for investors’ funds. So when interest rates are low, the yield on equities doesn’t have to be very high to make them look relatively attractive.
With this in mind, Allum has compared the historical relationship between dividend yields and bond yields in Japan and found that whenever the latter exceeds the former, stocks tend to bounce. Right now stocks yield 1.4% and the bench market 10-year bond yields about 1.7%. So we aren’t quite there yet, but we aren’t far off either.
It’s also worth noting that if it is exposure to the growing consumer culture in Asia you are after, you can get it via the Japanese market with rather less risk than you have to take if you buy directly into Chinese equities.
Think for example of Yamaha (7272). As analysts at Asia specialist brokers CSLA point out, it is the world’s second-largest motorcycle maker (after Honda); it makes about 40% of its earnings from emerging markets; and it has recorded double-digit earnings growth every year for the past five years. Yet it trades on a P/E of only just over 10 times. That’s too cheap.
Just now everyone hates Japan. But the economy is growing steadily and its shares aren’t expensive. Over time, I think investors in Asia will find Japan isn’t a bad place to be.
First published in The Sunday Times 14th October 2007