Gerard Minack on Japan
A Note From the Down Under Daily
Hello, Readers and Subscribers:
Way back in the mid-1980s when Ronald Reagan was in the Oval Office, the elder Haymaker, who began his career in finance in 1979, expressed one of his first reckless opinions: Japanese stocks were way too expensive. From that point, they proceeded to double. That would become a familiar outcome whenever he began to warn about overvaluation. Starting in early 1990, however, Japan’s indexes began one of the longest and deepest bear markets a developed-country stock market has ever endured.
Surprisingly, though, despite many years of poor, even pathetic, price performance, overall P/E ratios on Japan’s stock market remained far above most rich-country indexes, including the U.S. This was likely a function of the TOPIX and Nikkei, its two main indexes, hitting a P/E in the vicinity of 60 in the late ‘80s. It took a long time for valuations to normalize but in the aftermath of the Global Financial Crisis (GFC) P/Es fell to the mid-teens. By the end of the last decade, the TOPIX, or Tokyo Stock Price Index, currently comprised of 1,716 companies, had gone nowhere since the start of the 21st Century. In fact, even as late as last year, it was below where it traded in 1989!
Per this week’s Guest Haymaker, authored by my Aussie mate, Gerard Minack, a name very familiar to our regular readers, at its zenith in the late 1980s the CAPE (Cyclically Adjusted P/E; also known as the Shiller P/E) was almost four times its developed world peers. Now, however, with the S&P trading north of 20 times next year’s likely overly optimistic earnings estimate, the TOPIX is around 13 times profits projections. It currently trades at a 15% discount to its peer countries and just 60% of book value (price-to-book, or P/B, in his note).
Additionally, its home currency, the yen, is also markedly undervalued. Most pundits believe, and we agree, that the yen is the cheapest rich-world currency. Ergo, it’s an unusual combination of an underpriced market and currency. Illustrating this, as recently as June, the TOPIX hit an all-time low in yen terms vs the dollar.
Again, in yen, not dollars, the TOPIX had a massive breakout in early 2021. That was when it burst above its pre-Great Recession/GFC peak. As so often happens, after that upside “range expansion” it scooted over 40%, once more in yen terms. Its collapse versus the dollar wiped out almost all of that appreciation for U.S. investors.
As you will read, Japanese corporate profits have been strong. Its earnings per share have outperformed most of its peer countries. This reflects Japan’s herculean effort to returns on equity (ROE). Unquestionably, this has been working.
There are a couple of significant caveats, however. One, as Gerard notes, is that Japan’s sizable export sector is vulnerable to a global recession. In Team Haymaker’s view, that’s a serious risk. Also, which he doesn’t point out, but other experts have, is that should the yen keep appreciating, it will likely squeeze export-oriented companies profits. Those are already feeling pressure from, for it, hefty wage increases to Japanese workers. However, there is a positive offset to that in terms of increased domestic consumption, as Gerard also notes.
Net, net: the Japanese market remains an attractive destination for U.S. investor capital. As usual, dollar-cost-averaging is advisable, particularly when taking into account the Three Rs: Rising Recession Risks. Based on yet another punk jobs report this morning, that’s a threat to which Wall Street is belatedly smelling the coffee.
“According to the most recent data, approximately 40% of Japanese corporate earnings are generated in foreign currency. This significant proportion underscores the global integration of Japanese companies, many of which have extensive operations abroad, particularly in sectors such as manufacturing, technology, and automotive industries. The strong reliance on foreign markets naturally makes these companies sensitive to fluctuations in the yen’s value against other major currencies—particularly the US dollar and the euro.” -Grant Williams
The medium-term bull case for Japan remains intact
Gerard Minack, Down Under Daily
Originally published on September 2nd, 2024
Japanese equity returns have largely been driven by yen weakness through the past decade. In dollar terms Japan’s relative performance hit a new all-time low in June. However, the medium-term bull case for Japan remains intact: the market is cheap; return on assets and margins have risen; US$ EPS growth has been solid; emerging domestic inflation pressures point to rates normalising; and if the next global cycle is capex-led, as I expect, it will play to corporate Japan’s strengths.