Value in the land of the Rising Sun

11th January 2012

It's been a dismal few decades for the Land of the Rising Sun. And now, not only are there natural disasters to contend with, but a global economic and eurozone debt crisis to pile on the bad news.

China replaced Japan as the world's second-largest economy in the summer of 2011. While not unexpected, for a country that prides itself on an innovative, successful economy, this is a severe blow.

But does this spell another bout of poor performance for investors?

Experts have repeatedly predicted a recovery and return to sustained growth in Japan over the years, but so far this remains to be seen. According to Invest with an Edge, there are, in fact, many reasons to avoid Japan, including that the yen was very strong in 2011, which is "bad news because it makes Japan's exports relatively more expensive. And exports are a big part of the national economy…" A large chunk of Japanese exports go to Europe, and given the problems in the region, this won't help.

Yet can it really all be bad? After all, at one stage Japan seemed to be decades ahead of the rest of the world. In the 70s and 80s, the country was seen as the world's technological and industrial leader. It rapidly became the second biggest economy – but is now battling huge debt. Japanese sovereign debt amounts to a staggering 225% of the country's GDP.

But ignoring Japan's sinking index, could there still be a recovery? Perhaps the country is one where investors should turn a blind eye to an index's torrid performance, and focus on long-term fundamentals. While Japan has been battling a more of debt and sluggish growth for years, with fears the West will head the same way, are there still lessons to be learned and opportunities for profit?

Michael Wood-Martin, manager of the Henderson Japan Capital Growth fund, says: "There is much misconception with regard to the performance of the Japanese stockmarket. What investors tend to omit when looking at the returns from stocks is to incorporate the currency effect, which has been marked as the yen has risen against virtually all other currencies. Granted the returns from the S&P have been better but Japan, when currency adjusted, follows a similar trading pattern to developed markets. So, for example, although the index is below the depressed low of 2003 when global markets bottomed, in US$ terms the index is markedly above this level at present.

"Japan may not be the most exciting of economies especially given its geographical location nestled close to vibrant Asia but in comparison to western counterparts the country is looking increasingly attractive.

"The economy, much maligned and almost forgotten about, can offer a clean bill of health having completed its balance sheet restructuring whilst offering a large liquid stockmarket with companies which are typically cash rich and increasingly investor focussed."

Which index should you rely on?

Wood-Martin says: "The Topix index is a well established index which in recent years is being superceded by the MSCI Japan index which has a fewer number of stocks but giving a close representation of the overall index. Both these indices are geometric and both have the full validity of being benchmark indices – which one is used is largely a matter of choice. Topix has a much higher number of stocks and a much longer small cap tail. The Nikkei 225 is an arithmetic average and is not widely used as a benchmark index but is referred to in new bulletins and other such announcements."

Japan is well known for reaching economic success through cheap, innovative, efficient manufacturing. They may have competitors in India and Taiwan, to name a few, but they are capable of rising to the challenge, say some financial pundits.

 "False dawns and Japan have become synonymous for investors," says independent financial adviser Bestinvest. "But we believe Japanese equities have been unduly punished and that the market is well placed for a rally."

So what are the positives, according to Bestinvest? These include: Japan's banks being among the best capitalised in the world; a strong currency treated as a safe haven by investors; healthy company balance sheets – the market as a whole is trading at a very low valuation, and reconstruction post the tsunami, which will benefit Japanese companies.

After all, Buffett is keen…

Bloomberg reports that billionaire investor Warren Buffett is unfazed by the recent scandal at Japanese camera maker Olympus Corp  and is looking for investment opportunities in the nation's companies.

"We're looking for companies that have some kind of sustainable competitive advantage," Buffett said. "The fact that Olympus happens here or Enron happens in the U.S. doesn't affect our attitudes at all."

 "There are lots of opportunities in Japan," Buffett, 81, said in Iwaki city, adding that the earthquake hasn't changed his view on investing in the country. He said he is interested in "businesses that will be around for many, many decades."

There are certainly lessons to be learned from Japan. The nation has had decades to come to terms with its decline, and focus on tackling this efficiently, rather than the panic spreading in the West. After all, the country remains one of the most prosperous on earth, with a strong welfare system, high life expectancy and low unemployment, with hardly any crime. So is it time to take a punt in the hope its sun will rise again?

 

More from Mindful Money:

Just how strong is China’s economy?

What does the Olympus Scandal tell us about Japanese corporate culture?

The Lost Decade – Is it all doom and gloom?

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17 thoughts on “Value in the land of the Rising Sun”

  1. Chris, Leeds says:

    Long time reader, first (well second, I was late to the last blog) time poster. 

    My question is that if the money given to the S.European Eurozone states has been in Euro’s and a state subsequently leaves the Eurozone and re-establishes their own currency, are they still liable to payback in Euros?  Depending on the potential devaluation this could be critical unless I have misunderstood.

    1. Rods says:

      Hi Chris,

      If the country defaults and refuses to pay anything back Argentina style, the denomination of the currency will not be important!

      My understanding is that the principle of “Lex Monetae” applies so that everything that governs the currency of a country can be determined legally by that country.

      There is the issue here that the Euro could also still be considered as the country’s currency, so the country has dual currencies, this will one for the lawyers I think?

      Sovereign debt is normally issued under local law, but some contract maybe written under another law like English. I seem to remember there were some issues with this applying to a small number of contracts when Greece did its haircut with debt held by banks and other funds a few months ago.

      1. Rods says:

        I should add on this principle, that say it is Greece and they set the rate at 1 Euro = 1 new Drachma, then in the Sovereign debt contracts written under local law they could make the contract repayable in new Drachma on this 1 for 1 basis.

        When the Drachma falls then the holders of the bonds would take the hit. Which would not make the ECB balance sheet look pretty.

    2. Anonymous says:

      Hi Chris and welcome of my part of the blogosphere. The comments bit anyway….

      Euro area money lent to S. European states is in Euros. So EFSM and EFSF lending is in this form.The situation is different for the IMF which actually lends in Special Drawing Rights (its currency) converted into a Euro amount.

      I do remember documents insisting on Euro repayment and the European Investment Bank went to some trouble a month or two ago to re-write its documentation to Greece to reinforce this point. However as Rods has already pointed out should a country redenominate a loan what will/can they do?

      So it is in fact uncertain and if I was responsible for a New Drachma/Peseta/Lira I would redenominate the loans. Wouldn’t you?

  2. Anonymous says:

    Shaun, I can’t help thinking that, among the many interconnected problems that now beset us, the insolvency of many (most?) banks is key. Maybe if Germany is forced to confront that problem, we will find that the obstacles to the ECB doing what the Fed and BoE are doing, and what the BoJ could always do (i.e. print as much money as needed) will disappear. Whether that will work out well or not I don’t know.

    1. Anonymous says:

      Yes this is why for the UK my suggestion was that we need to reform our banks before we do anything else and that without it we will struggle to get out of our current malaise. This is true for Germany but on a lesser scale as finance is a bigger proportion for the UK.

      I remain a critic of QE type strategies as so far there is no evidence that it has ever worked. And we are getting plenty of data as it is tried in ever larger amounts (UK as of today £333 billion).

  3. Anonymous says:

    Shaun – another interesting insight. Concerning German figures, it would be interesting to compare German import/export figures for the rest of the EU with those for countries outside the EU. If we are seeing German imports/exports wither globally, then trouble will surely strike.

  4. KDH says:

    Great article as usual Shaun.
    I read a lot of blogs (ZeroHedge, D. Telegraph which I’ve seen you post on), and a lot of people are concerned that the most likely outcome of this crisis is a breakdown in the banking industry, which due to the tightly knit global supply chain (JIT, etc), could have very serious effects in terms of social cohesion.
    I realise that this may be beyond the scope of your blog, but wondered where you see the eventual end-game.  It appears, as a concerned on-looker, that the elite (both political & financial) are either ignorant of the effects on the ground, or simply don’t care. The speed of market events is so much more than the response times of the political class, so at some point it seems plausible that they will simply become swept away by such events.
    Do you think it’s likely that the outcome of this will lead to inward looking government, protectionism, or even worse outcomes?

    1. Drf says:

       Hi KDH,

      To your last question I can only answer “Yes!”

    2. Anonymous says:

      Hi KDH

      I am travelling in an opposite direction to those concerned about a breakdown of the banking industry as I think it already has! Accordingly I press for bank reform and a break up of our banking sector as I think the clock to a possible breakdown of social cohesion is ticking already. However a few light flashes of it may not be all bad as those in charge need a shake-up as you imply.Of course it is a far from ideal road to travel as matters can get out of hand…..

      As to you final questions I think we do have inward looking out of touch government. We do have governments trying to manipulate currencies and some types of protectionism…

      One of the things which makes me most uncomfortable as a democrat is that right now it is not working well at all. This is one of the reasons why I suggested direct elections for the MPC as we need to change.

  5. The_forbin_project says:

    funny I read

    ” her ability to support an increasing number of bailouts”

    as

    “her ability to import  an increasing number of bailouts………”

    Forbin

  6. JW says:

    Hi Shaun
    We are getting closer to the point when the risks associated with TARGET2 exceeed the advantages of a weak Euro. At that point Germany thinks and acts in self preservation. 

    1. Anonymous says:

      If Germany exits the euro, it can leave existing bunds denominated in Euro – counteracting the TARGET2 losses.

  7. Anonymous says:

    Let’s assume for a moment, Shaun, that German bank bad loans equate to claims on the periphery. Do we then see the raison d’etre for Germany’s attempts to hold the mess together?

    1. Anonymous says:

      Hi Shire

      Partly although I still think that the worst liabilities of German banks lie across the Atlantic in the US. Also there is the Euro which makes Germany’s export position much more healthy than what it would be under a new Deutschemark.

      Here is another thought for you. Germany leaves the Euro. This would solve some problems but create a rising currency. So she then pegs to the Euro at a higher rate. Sneaky if pre-planned but….

  8. Spacemanc says:

    Surely one of the biggest risk’s for Germany, is the end of the Euro causing their exchange rate to go through the roof and destroying their exports?

    I can’t believe that the Southern European countries do not pressure Germany more on this aspect. They’re currently playing a large part in making Germany competitive and yet don’t seem to be getting much in return, apart from loans and austerity which are only making things worse.

    1. Anonymous says:

      Hi Spacemanc

      I agree that the leaders of the Southern European countries have in effect sold their populations a pup. I have made a suggestion of what could be tried to Shire above but the danger of course is that the new Dm would go through the roof before you could peg it back to the Euro…

      We may yet see my “Three Euros”…

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