The hate-fest surrounding Japan appears to have “risen to new highs in recent weeks”, says CLSA’s Damien Kestel in his weekly newsletter Bits & Pieces. In fact, he cites the Oxford (American) dictionary’s word of the year, “Unfriend”:I don’t know who selected this word or for what reason but I’m guessing there is a reasonable chance that those behind the decision are Japanese fund managers and the use of the word relates directly to their portfolios… which is understandable considering the Topix has underperformed the MSCI World index by 37% since March and the Mothers Index has fallen out of bed in over the past month. Is this the ultimate contrarian call? Despite the despair some think so.
Just to back the view up, Kestel gives us a few sample comments:
“To be honest, this is the worst that I have ever remembered Japan to get” (Japanese equity salesman)
“I hate that market” (Anonymous investor)
“The MSCI Japan’s relative trend versus the MSCI World and MSCI Asia Pacific continues to drift lower. Global and Asia Pacific investors should remain underweight Japan” (CLSA chartman, Laurance Balanco)
“It’s quite likely that Japan is the only significant market in the world that is not seriously overvalued” (Investor and commentator Andrew Smithers).
Indeed, the FT, in its more typically understated style, proclaimed on Thursday that “equities cheer eludes Japan”.
Well rather. As the report noted:Japan’s benchmark Nikkei 225 Average has risen 9.2 per cent since the start of the year, far less than the 20 per cent gain for the Dow in the US, the 25 per cent for European stocks or the 22 per cent for the UK’s FTSE 100. But even the Nikkei has done well compared with the broader and more representative Topix index. On Wednesday, the Topix closed at a six-month low of 850.06, leaving it 1.1 per cent down for the year and the only developed market index to have fallen this year.
Japan’s miserable performance comes just ahead of an unhappy anniversary: it is 20 years since the Nikkei peaked at 38,915.87 in December 1989, compared with Wednesday’s 9,676.80 close. One reason that Japan has lagged behind in recent weeks is that investors have been taking their money out of poorly performing markets to invest in those they consider winners. Tokyo Stock Exchange data show net sales on the market for the past two months.
Not only that, there is a looming flood of new equity issuance from financial institutions and corporates. Companies have already issued $39.5bn of new equity this year, according to Dealogic. And that is set to continue, with MUFG, Japan’s biggest bank, on Wednesday announcing plans to sell as much as Y1,000bn ($11.2bn) in new shares. Other banks are expected to follow suit.
CLSA’s Kestel cites a Japanese equity salesman saying: “It is extraordinary that we are getting not a peep out of domestic institutions , when listed corporates are issuing largely dilutive new equity [in many cases] in order to buy more real estate”.
But, there might be some glimmers of hope amid all the bad news. As the salesman notes, there are clear signs of capitulation selling: “Fund redemptions in small caps have led to substantial losses on margin positions for retail investors”. One Japanese broker noted it was seeing retail investors liquidate their underwater margin positions. And that, says the salesman, “usually signals the bottom of the market”.
Nicholas Smith, director for equity research at broker MF Global, thinks the “hate-Japan” fest is overdone. In a note this week he says the foreign media paint a “last chopper out of Saigon” picture [who, us?] as “Japan’s remaining foreign fund managers tear each other’s eyes out to get on that last helicopter out of recession-torn Tokyo”.
But, “the tale of the tape is more sanguine: foreigners are net buyers of the market. That’s the good news: the bad news is that practically nobody else is.” Continues Smith:
Foreigners have been net buyers again since the start of the new fiscal year: They have bought a net Y3.1trn ($35bn) since the start of the new fiscal year, in April. Does that mean that the foreign shareholding ratio of the market has gone up again? Alas, no: Y3.1trn just happens to be the amount of new equity issued so far this year — with the spigot about to be opened on a flood more that’s in the pipeline. MUFG is probably the one at the forefront of most people’s minds, but Mizuho is likely to dwarf that.
In fact, the probability of one of the upcoming offerings failing and having to be withdrawn seems quite high, especially for the huge bank issues, notes Smith adding: the next couple of months are “likely to resemble a yard-of-ale drinking competition, with similar risks for the self-respect of the issuers”.
That said, foreign buyers are still hanging in there in Tokyo. At the peak, in January 2008, foreigners accounted for 73 per cent of all Japanese equities trading: in the latest week, to November 13, they still accounted for a mighty 55 per cent of trading.
Explains Smith: “As a result, when foreigners buy, the market goes up: when they stop buying or sell, it goes down. There is a strong correlation between net buying by foreigners and the week-on-week moves in Topix”.
As for those burnt retail investors: As a rule of thumb, if individual investors’ losses on margin trading are less than 3 per cent then the market is overheated; if they’re actually in the money, “it’s almost invariably a case of Icarus ascending, and the market is poised for a fall”, notes Smith.
All, however, is not lost for Topix, in his view:
She is not pretty, but she is certainly cheap. As much as 66% of the stocks on the main board are trading below book, and the index itself is trading at exactly book:
Earnings are terrible, so the earnings yield is low, but the risk free rate is lower. The earnings yield is able to beat the long bond by 1.55pc.pts. with JGBs at just 1.3%. Being a midget is a natural advantage when you’re limbo dancing. It is also attractive that the dividend yield leaves the bond yield in the dust, though it is something of a concern that the payout ratio is a high 69%. Not only has the dividend yield been low, historically, in Japan: companies have also cut them more often than US companies.
Meanwhile, Andrew Smithers (who incidentally also thinks that the US stock market is over-valued by about 40 per cent) says profit margins of Japanese companies are likely to improve as companies invest less, lowering depreciation costs which, in Japan, eat up about two-thirds of earnings compared with less than half for US corporations.
Whatever the direction of Japan’s lacklustre stock market, perhaps Kestel sums up the investment conundrum with his conclusion: “In the land of the hated, are there any bargains?”
Related links:
Goldman: M&A key for Japanese equities in 2010 – SeekingAlpha
Japanese equity raisings: So much value, so much dilution – FT Alphaville
Worst seems to be over for Japan dividend cuts - FT
Japanese equities – an elusive value trap – SeekingAlpha