KT - what you think of this?
BUYING TOKYO
By C. Alexander Green
Japan is 14 years into an economic crisis. In fact, the
world's second-largest economy has been stagnant for so
long it has essentially abdicated its once-leading role in
Asia and the global economy.
There are several reasons for this. The country experienced
a huge bubble in its stock market in the late 1980's. (In
fact, this bubble bore more than a passing resemblance to
the technology stock mania of the late 1990's.) In 1989,
Japan's index - the Nikkei 225 - soared to 39,000 and more
than 100 times earnings. It was accompanied by an equally
magnificent real estate bubble.
Unfortunately, Japanese banks were busy lending money
against these pie-in-the-sky real estate values. More than
a decade later, property prices in Japan have fallen over
80%, devastating the Japanese banking system.
In the early 1990's, the U.S. had its own massive problem
in the savings and loan industry. The Resolution Trust
Corporation was formed to clean house. And it did.
Nothing like this has happened yet in Japan. So far, the
country's inept political system has refused to address the
problem. As a result, the Japanese economy stumbles along,
zombie-like, while its bankrupt banking system continues to
lend money to technically insolvent companies.
Politicians in Japan have made the situation even worse.
Rather than cutting taxes sharply to stimulate the economy
early on, the government enacted huge spending programs to
stem the economic decline. This involved massive public
works projects, including highways that weren't needed and
bridges to nowhere. In short, Japanese taxpayers saw more
pork than the average butcher at Oscar Meyer.
Needless to say, it didn't work. The dysfunctional banking
system and the huge budget deficits resulted in a
relentless deflation that has been eroding prices in Japan
for over a decade. As a result, consumers - ever fearful
that things will get even cheaper - refuse to spend. And
that has caused the deflationary cycle to grow ever more
vicious.
In fact, things have gotten so bad that last year Moody's
took the unprecedented step of downgrading Japan's credit
rating from A1 to A2. That's lower that Botswana's.
All in all, over the past decade and a half, Japan has seen
the bursting of an investment bubble... a sickening
deflationary crisis... a market index that has plummeted
82%... and the emergence of a very black mood among
consumers and investors. Yet for contrarian investors, now
- when abject pessimism about the country's future is at
its zenith - may actually be an historic buying
opportunity.
There is a strong case to be made that Japanese shares are
greatly undervalued. For starters, the Japanese government
is finally getting serious about banking reform. It's true
the ruling Liberal Democratic party continues to try to
foil the initiatives of the Koizumi government. But as the
crisis has escalated, intense pressure to make meaningful
changes to the banking system keeps growing.
Secondly, real estate prices have now fallen much further
than rents. Many Japanese properties now yield more than
10% annually. That provides support for real estate at
these levels and indicates a bottom is at hand. With
returns this high, it's unlikely Japanese property values
will fall dramatically from here.
Another positive sign is that Japanese profits are already
on the upswing. According to Morgan Stanley, profits for
listed companies in Tokyo (excluding banks and other
financial concerns) rose 80% in the fiscal year that ended
in March.
Yet by many measures, Japanese stocks are among the
cheapest in the world today. An amazing 60% of Japanese
listed companies have a market capitalization that is lower
than the value of their net assets. (U.S. companies in the
S&P 500, by comparison, sell for more than five times this
much.)
More importantly, every bit of bad news detailed above is
already reflected in Japanese share prices. No one is going
to sell Japanese stocks today based on the gloomy news of
the past decade. But a glimmer of positive news - like
genuine banking reform - would drive Japanese share prices
substantially higher.
And that may happen soon. The Japanese people have socked
away more than $250 billion in cash. Unfortunately for
these thrifty folks, Japanese government bonds pay only a
smidgen more than nothing. (Mortgages of less than 1% are
commonplace.) When the stock market begins to gather steam,
huge sums of cash are likely to leap from the sidelines,
adding fuel to the fire.
As chief economist Stephen Roach of Morgan Stanley put it,
"the Japanese consumer may represent the greatest source of
pent-up demand for a major economy in the modern era."
Finally, it's important to note that global money managers
have managed to beat the international index over the past
decade just by severely underweighting their exposure to
Japan. If the Japanese market starts to take off, they will
be forced to invest billions to keep from underperforming
their benchmark.
And let's not forget that Japanese stocks provide a
wonderful dollar hedge. If the dollar falls 20% against the
yen, for instance, Japanese shares will be worth 20% more
in dollar-terms, even if the Japanese stock market goes
nowhere.
There is risk in this scenario. By backing away from
meaningful banking reform, the Japanese political
leadership may end up winning the Rubber Backbone Award. Or
some other yet-unknown screw may come loose.
For that reason, I'm recommending a conservative way to
capitalize on a rebound in Tokyo: buy the whole market.
Just as you can buy an index fund based on the Dow, the S&P
500 or the Russell 2000, so too can you buy a publicly
traded index fund that replicates the performance of the
Japanese market. It's called the MSCI Japan Index Fund
(AMEX: EWJ).
This is the most heavily traded international index in the
U.S. And it has plenty of liquidity, with more than $1
billion in assets. It's made up of many companies you
already know and patronize. For instance, the top ten
holdings - which make up over a quarter of the fund -
include Toyota, NTT DoCoMo, Canon, Sony, Honda and Nissan,
among other well-known international brands.
Buying the Japanese market today is contrarian investment
at its boldest. But as investment legend John Templeton has
often said, "the greatest bargains can only be found at the
point of maximum pessimism."
Sell New York. Buy Tokyo. |
