Buying Japan

Benj Gallander and Ben Stadelmann
Friday, August 1, 2003

By definition, we contrarians have to have pretty thick skin. People with a more mainstream approach to the market are bound to be dubious of the downtrodden assets that attract us. And to champion the case of buying into Japan over the past year, we needed industrial-strength rhino hide.

While a recovery in telecoms, or even airlines, was plausible to some, our purchase of the Japan Equity Fund last September at $4.66 was beyond the pale. This disbelief appeared to be well placed on April 28, when the Nikkei plumbed yet another historic low of 7,607.

Since then, the Japanese stock market has turned in a stunning performance. On July 8, the 10,000 level was breached, an amazing 31 percent spurt in nine weeks. Also impressive were trading volumes of 2 billion shares a day, a level not seen since the glory days of 1989.

The buying stampede was triggered by the sudden mood swing amongst North American institutional investors from abject fear of Japan to the worry of being left behind.

Opinions vary on what sparked the tidal shift. Abating worries about SARS certainly helped. The Bank of Japan’s new chief, Toshihiko Fukui, has shown a willingness for bolder moves at reform than his predecessor. Moderating oil prices, in the wake of control of the Iraqi fields, helps the developed country most dependent on imports.

But lovers of brass tacks and counting beans will find a far more obvious reason: the success of Japanese corporations. Despite their reputation for being ossified institutions stuck in a decade-long recession, the numbers suggest a different reality.

Take the automotive industry, for example. Toyota and Honda have healthy balance sheets, with debt/equity ratios of .93 and .88 respectively. Though earnings have slipped a bit, Toyota has a respectable profit margin of 4.9 percent, and Honda clicks in at 4.6 percent.

If you want to do some investing paleontology, take a look at General Motors and Ford, where oodles of cars rest in inventory, while rebates have crushed profits, with margins around the one percent mark. Both companies have awful balance sheets, GM’s debt/equity ratio is a miserable 22.4, and Ford comes in at 21.7. Will the real dinosaur please stand up?

Of course, skeptics point out that Japan marked a number of false dawns over the past few years. What is different this time is that the US star is definitely waning, with debt and deficits hovering like a plague of locusts.

US corporations continue to be miserly about capital expenditures, a direct consequence of a decade of overspending and poor capital allocation. In Japan, a survey indicates that large enterprises have revised budgeted expenditures for the year ending March 2004 from -0.8 percent to +4.9 percent.

Not surprisingly, the Nikkei has dropped a few hundred points on profit taking. No question, there are bound to be ups and downs in the years ahead, but this dawn seems real enough to make our Japanese holding a favourite.