For retail investors, domestic stagnation and a deflationary environment have been a red flag, while many institutional investors have had their fingers burnt following one of the perennial calls that “now is the time to invest in Japan”.
There are clear reasons not to invest in Japan. Since the country’s main stock markets, the Nikkei 225 and the Topix, hit their peaks in the late ’80s there have been numerous false dawns, with markets looking like they are about to rally but falling off relatively quickly. A glance at the performance of the Nikkei 225 over the past 20 years will show significant falls in the late ’90s and early this century, with each trough getting lower and lower following only a short rally at best.
The shrinking and ageing demographic of the country is also less than favourable from an investor’s viewpoint. According to the Central Intelligence Agency of the United States’ World Factbook, Japan had negative population growth of 0.08% in 2011, while almost a quarter of its population are over the age of 65. Add to this the post war “baby boomer” generation which is just reaching retirement now, and you can see why an investor could wonder how the country will continue to support itself.
Deflation concerns
Deflation has also been a major issue for investors. How can one expect to generate investment returns in a deflationary environment? Indeed, how can a business expect to generate reasonable returns in a deflationary environment?
Japan’s deflation is of course inextricably linked to the country’s GDP which, since the crash of the late ’80s has slowed markedly. For three decades, overall real economic growth had been stellar, with average GDP growth in the ’60s a huge 10%, 5% on average in the ’70s and 4% on average in the ’80s. Once into the ’90s however, this slowed significantly, averaging just 1.7% over the decade and, while this did pick up, last year GDP was back down -0.7%.
Due to these falling GDP figures, and measured on a purchasing power parity basis, Japan last year fell to become the world’s fourth largest economy after second place China, which surpassed it in 2001, and now third-placed India.
The latest inflation figures also support the view of a shrinking economy, at -0.7% in 2010 and -0.3% last year. With a debt to GDP ratio of 200% in 2010 and 211% last year, the reasons to avoid Japan seem compelling.
These fairly ferocious statistics must make the job of marketing an investment product which invests in Japan tricky to say the least.
Tony Roberts, a Japanese equity manager at Invesco Perpetual, admits that often one of the first things he needs to do when talking to advisers and potential investors is dispel some of the myths that surround Japan.
Myth busting
But are they really myths? A stock market which has trended downwards for more than 20 years is surely an undeniable fact?
“It is true that the stock market itself has been a disappointment, there is no doubt about that, but it is not true that corporate Japan has been a disappointment,” says Roberts.
“The late ’80s are seen as the halcyon days of Japan, but in fact, if you look at corporate profit and the peak of the last cycle in particular, which was around 2007 before Lehman went bust, corporate profits were a lot higher than they were in the ’80s.”
Roberts explains that there has been a “cyclical uptrend” in corporate profits since the financial crash of the late ’80s, although the markets themselves have been in a “cyclical downtrend” – essentially a de-rating of the market. This has continued to give the impression of a down trending market overall.
Turning bullish
However, Roberts says the overpricing which had worked its way into Japanese equity markets in the ’80s had largely disappeared by the time of the Lehman crash.
“When (the financial crash of 2007-08) happened, Japan had de-rated to the extent that it was trading at a significant discount to book value. We reached around a 20% discount to book and that is a lot cheaper than any other developed market on a book value basis. That is when we decided to go bullish,” he says.
This goes some way to dispelling the “myth” that Japan, including its stocks, have been on a downward trend for 20 years, and perhaps to make a sensible investment, one needs to ignore the noise in an environment. So does the country’s 200% debt to GDP ratio really matter? How about its ageing population?
Gavin Haynes, investment director of UK-based Whitechurch Securities, says probably not.
“The domestic economy has little appeal,” says Haynes. “However, there are a number of global multinational companies which just happen to be domiciled in Japan – Canon, Sony and Honda, to name a few.
“Just because they are domiciled in Japan does not mean they should be completely ignored, and in fact, because they are domiciled there, means they are trading at very low valuations.”
Haynes says part of the reason these companies are trading relatively cheaply is simply because so many investors have “pretty much thrown in the towel” when it comes to Japan – both private investors and institutional.
“From a contrarian perspective, this provides an opportunity if the market does start to show some outperformance, because you could begin to see some considerable inflows, with investors putting right their underweight positions,” he adds.
The companies named by Haynes – Canon, Sony and Honda – are good examples of the type of company which can be found within the equity portfolios of most Japan fund managers – companies heavily technology driven, where Japan still has huge government investment, and exporters.
Technology plays
While the above named companies are very familiar to investors, there are other names which are also leaders in their class but which garner less attention. One example is Taiyo Yuden, an electronics company which supplies parts to Apple to make its iPhones – inarguably a recession-defying product.
Another example of a smaller stock which feeds into a bigger story is Renesas Electronics, which supplies microcontrollers to car manufacturers such as Mitsubishi.
These tiny electronic products are vital to new cars, making everything from the electric windows to the assisted parking work.
Of course, export-led companies, such as the automakers and electronics companies, have endured significant headwinds in the last few years, with the European downturn and now a slowdown in China having a significant impact on orders.
It is also worth noting a recent flare-up in tensions between China and Japan over the sovereignty of a string of islands in the East China Sea.
There was also last year’s earthquake and tsunami, which had a devastating impact on some parts of eastern Japan. The impact this had on stock markets has, according to Roberts, been real but not as damaging as one might expect, perhaps at worst revealing some supply and stock issues.
A further accusation levelled at Japan is that its corporate governance is weak. The recent scandal at Olympus confirming suspicions for some that at the executive end of Japanese companies, there is still far too much power wielded by too few. In retort, Roberts reminds us that Lehman Brothers was certainly nowhere near Japan, nor indeed was Enron.
That, perhaps is a better way to consider Japan – forget about looking for the rising sun and concentrate on those already risen and growing stronger.
