It's time to consider Japan (really!)
Yes, I wrote off investing in the country a long time ago. But one money manager with a stellar track record has made me rethink the issue. You should do the same.
By Timothy Middleton
At the recent Morningstar investment conference in Chicago, star fund manager Bill Miller concluded a rousing defense of equities this way: “I have one word for you: Stocks. I have one country for you: Japan. I have one stock for you: Sony (SNE, news, msgs).”
The audience, made up largely of financial advisers, was astonished. Japan?
After more than 13 years of plummeting securities values, at least four recessions and a terrifying slide into deflation, the world’s weakest major economy has been all but written off by countless analysts, including me. The result of this widespread distaste is a giant sales tent for bargain hunters like Miller, but still a very uncertain long-term play.
“The case for Japan is that the market is completely bombed out,” says Mark Headley, manager of Matthews Japan (MJFOX). “You’ve got all the sellers out. The only people who own Japanese stocks are diehards and some value investors. Any positive news comes as a surprise."
And surprisingly, positive news has come out of Tokyo lately, including a new boss for the Bank of Japan, a seeming halt to the precipitous decline of property values and some earnings turns at its largest corporations. As the only major nation losing the battle against deflation, moreover, Japan would benefit from the spillover effects of the Federal Reserve's fight to generate inflation domestically.
A change of direction
Japanese stocks have stood up and cheered. As of June 27, the average U.S. mutual fund investing strictly in Japan was ahead only 3% this year, but leaped 6% in the last month. At the same time, the double-digit gains of domestic mutual funds were slipping into the low single digits.
“The timing is about now,” proclaimed Miller, manager of Legg Mason Value (LMVTX), the only fund to have beaten the market in each of the last 12 years.
In March, Toshihiko Fukui was named to the top post at Japan’s central bank, ending the disastrous reign of Masaru Hayami. When he was Japan’s Alan Greenspan, Hayami cut interest rates far too little and far too late to help the economy, which has been spiraling down since 1990.
Shortly after Fukui’s appointment was announced, Japan effectively nationalized its fifth-largest bank, Resona. It and its larger brethren, including Mizuho Financial Group, the world’s largest, are the survivors of a group of more than a dozen large banks plunged into virtual bankruptcy. The bailout of Resona -- after slashing costs in a manner that had eluded corporate Japan till then -- seems to lay a floor under the rest of them.
Property values in Tokyo, famously stratospheric in the 1980s, have plunged for 13 years, but lately have stabilized. Among other things, real estate investment trusts have emerged to take property off the balance sheets of banks -- where they had never been marked down -- and securitize them with equity capital. Many Japanese corporations have cut debt by selling their headquarters buildings to these REITs.
Meanwhile, prices of Japanese stocks, once the highest in the world, have declined to more reasonable levels. Miller’s new best equity friend, Sony, trades at 16 times next year’s earnings forecast. Honda Motor (HMC, news, msgs) has a price-to-earnings ratio near 10. Moreover, with the dollar depreciating against the yen, Japan’s exports become more competitive, and dollar-based investors are getting a currency kick.
Greenspan to the rescue
The aid of the Federal Reserve is incalculable. “The Fed can force reflation,” says Miller. The currencies of both China and Hong Kong, each a major Japanese trading partner, are linked to the greenback. With the Bank of Japan under new management, it can likewise take action against deflation, which the prior administration viewed with equanimity.
Japan’s Prime Minister, Junichiro Koizumi, has yet to undertake any substantial reform of the country’s suffocating economic bureaucracy, but individual companies have begun to restructure. “They are being humiliated by Korea and they are terrified of the future competitiveness of China, and they recognize that their very survival is at stake,” says Headley at Matthews Japan.
With so many newly chastened companies writing off their nonperforming assets and focusing on their bottoms lines -- as opposed to their former focus strictly on revenue growth -- “It’s a lot more fun to be a portfolio manager in Japan today than it has been in a long time,” Headley says. Among the corporations turning to profits from losses is giant Matsushita Electric (MC, news, msgs), whose $1.1 billion in red ink last year is expected to be erased by slim earnings this year and stronger profits next.
Headley’s fund is only one -- albeit one of the best -- of about two dozen funds that invest strictly or principally in Japan. The Deluxe Fund Screener at MSN Money can quickly identify prospective investments based on the criteria you choose. Some of the top-performing funds focused on Japan include Dimensional Japanese Small Company (DFJSX), Fidelity Japan Smaller Companies (FJSCX) and Vanguard Pacific Stock Index (VPACX). While most posted losses over the past three years, they're beginning to show better results. For instance, the Dimensional fund is up about 12% over the past year.
Even if what’s occurring in Tokyo is nothing more than a trading rally, it could be remunerative to nimble investors. After three years of cascading losses in the mid-1990s, the average Japanese fund delivered an 8.2% return in 1998 and then soared 117% in the mad, tech-driven market of 1999. Tech has become the market’s leader again this year.
Remain wary
But absent genuine reform led by Koizumi, long-term investors should be wary. “We still can’t get terribly enthusiastic about Japan,” says Kurt Umbarger, a specialist in non-U.S. equities for T. Rowe Price. “They are still in a persistent economic malaise. It’s very difficult for local companies to generate meaningful profits when they’re fighting such a persistent headwind.”
Value investors have long been drawn to some segments of the Japanese market. Marty Whitman, the noted manager of Third Avenue Value Fund (TAVFX), made a successful foray into Japanese insurance companies in the late 1990s. Even T. Rowe Price, known as a thrifty equity shop, has been nibbling lately at export-oriented companies such as Toyota Motor (TM, news, msgs).
I confess I have taken fliers on Japanese stocks; at the end of 1998, I bought a chunk of T. Rowe Price Japan (PRJPX), and then displayed rare good sense when I sold it at the end of 1999. (If only I had sold my U.S. equities at the same time.)
But for now, I am content to get Japanese exposure through diversified funds, leaving it to their managers to decide whether and the degree to which they will venture that way. To an even greater degree than socialist Europe -- Germany’s chancellor is talking tax cuts! -- Japan remains committed to a paternalistic, isolationist market that hinders its economy.
At the time of publication, Timothy Middleton didn’t own any securities mentioned in this article. |
