Discounted Japan a proxy for global growth

The majority of the economic damage caused by Japan’s natural and nuclear disasters will be felt in Japan itself, with rolling blackouts hampering industrial production. But much of the Japanese economy is outwardly-focused, both in terms of sales and—to a lesser extent—production.

Reaction to the disasters sent the Nikkei lower by about 20%. While it has already regained half of its initial loss, it is back to level it was at in November 2010, when Japanese stocks were already seen as undervalued.

“Coming into this calendar year, I was turning more positive on Japan,” says Stephen Way, manager of the AGF Japan Class fund and the AGF Global Equity Fund. “In the Global fund, we’ve been going from an underweight position to a neutral position. In this most recent market turmoil, we’ve been adding to our position.

“From a stock market perspective, looking out 12 to 18 months, I would be bullish.”

He says valuations in the Japanese marketplace were favourable in late 2010; on an earnings basis, Japanese equities were trading at parity with the rest of the world. On a price to book basis, Japanese companies are now selling at a 40% discount to the rest of the world.

“I’ve been looking at Japan now for 15 years, and it’s always been at a premium,” he says. “To be able to get Japanese companies at parity—and some are trading at discounts, on a stock by stock basis—is unusual.”

Prior to the earthquake, tsunami and ongoing nuclear calamity, Japanese earnings estimates were being revised upward, reflecting the Japan’s position as a proxy for global growth, Way says.

“When global growth is accelerating, that is typically good for Japan. That was coming through in our earnings estimate revisions for companies that were exposed to global growth,” Way says. “As long as you’re positive on global growth, and as long as you think this nuclear situation can be resolved, then there are opportunities for stock pickers to go into that market and find some longer term value.”

Demand for electricity is currently 25% more than supply, and could rise to 35% in the summer months. Its unclear how quickly power production will be brought back to pre-quake levels, and rolling blackouts are causing problems for industrial production.

“I wouldn’t be surprised to see a technical recession in Japan, because of the sharp decline in industrial production,” he says. “But after that, a period of reconstruction will generate economic growth.”

Domestically focused sectors, such as financials and utilities, will bear the brunt of the triple disaster. Industrial and technology sectors will feel the least impact, as they tend to focus on the export market for their goods. Canon, which is one of his fund’s holdings, derives roughly 80% of its sales from outside of Japan.

“The challenge for those companies, historically, has been the strong yen,” Way says. The yen surged following the tsunami, as insurance companies sold off billions in foreign assets, repatriating the capital ahead of the massive value of claims that would be filed.

“What gives me some reason for optimism is that we saw a concerted intervention on behalf of the G7 economies to step in and sell yen, in order to stop it from appreciating,” Way says. “It’s in nobody’s interest, either domestically or outside of Japan, to see the yen strengthen dramatically from here.”

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.