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In Japan, the recovery is real
Bank reform has begun to pay off. A confident public has discounters' cash registers ringing. And an increasingly prosperous neighbor has only just begun to spend.
By Jon D. Markman
Stop me if youve heard this one before: The Japanese economy and stock market, the most disappointing in the world over the past 10 years, are zeroing in on a genuine recovery.
Japanese stocks, represented by the Nikkei 225 ($NI225), are up more than 26% so far this year, about half again as good as the 15% surge in the Dow Jones Industrials ($INDU). That entire move has come since the start of May, when the government announced it would use the reserves of its postal savings system to buy both Japanese stocks and exchange-traded stock funds. Although the statement was met with skepticism by investors at the time, it looks like they meant it: The iShares MSCI-Japan (EWJ, news, msgs) exchange-traded fund has zoomed 47% since.
Tokyo stocks have staged three serious rallies since their dizzying 70% descent began in 1990 -- in 1992, 1995 and 1999 -- and all ended in failure. But the latest advance could be different as real governmental reforms, a historic opportunity to participate in the explosive growth of China and consumers new appreciation for discount retailing appear to have combined to create a more solid foundation for future growth. Last week, a survey of large manufacturers by the Bank of Japan showed that chief executives feeling confident about business conditions outnumbered those who are pessimistic for the first time in three years.
Past disappointments hard to forget
Mark Headley, manager of the Matthews Japan Fund (MJFOX), which has doubled the advance of the Nikkei 225 this year with a 58% ascent, is among the half-believers. This could be for real, he said, sounding the skeptical tone of an investor who has been burned several times before.
Why the skepticism? You cant take feelings of confidence to the bank. Japan has kicked away vast wealth in two insane periods of its modern history: First, when it attacked China, Southeast Asia and the United States in the 1930s and 40s in an attempt at global domination; second, when it blew the money earned during its emergence as a world-class manufacturing power in the 1970s and 80s. In the latter period, politicians and bureaucrats beholden to special interests in the construction sector and rural communities cemented half the country -- wastefully building eight-lane highways to tiny villages -- and looked the other way when banks piled up a mind-blowing variety of bad real-estate debt and created tangled, corrupt webs of interlocking share ownership with companies they financed.
For years, a cloak of willful denial hid its devastating debt from the world, leading outsiders to believe that Japan was the first place in the world where socialism seemed to work. You had lifetime employment, workers singing company songs, homes bursting with every possible electronic convenience and no evident pockets of poverty with unemployment at just 2%.
The cracked foundation of this miracle was the notion that filial ties trumped capitalist efficiency. A multilayered distribution system based on social obligation instead of market forces put as many as five middlemen between, say, a golf-club manufacturer and a consumer, making goods in Japan more expensive than anywhere else in the world. Ultimately, the concept stretched too tight: Consumers stopped buying, margins thinned to nothing, nationalist arrogance climaxed and geopolitical troubles intervened. The stock market blew up, real estate prices cratered and the unraveling of obligations and dishonesty has taken more than a decade to play out.
Japan today
Today, the percentage of Japan's labor force in manufacturing jobs is twice that of the United States -- 30% to 15%. But recently, well-run companies such as Honda Motor (HMC, news, msgs) have defied their stodgy peers, such as Toyota Motor (TM, news, msgs), by shipping jobs overseas to lower-cost facilities in China, Malaysia and Vietnam. While that has made corporations more efficient, the fear of job loss stymied consumer confidence: 55-year-old factory workers and salarymen scared to death of losing their jobs to the rising colossus to the east dramatically held down spending, causing gross domestic product growth to slow to less than 1% in the 1990s.
Whats new now? With unemployment stabilizing at around 6%, domestic consumption has finally started to show signs of life and a pent-up demand for electronics, apparel and motor vehicles has led the economy to start to grow again. The Asahi newspaper reported that GDP for the second quarter registered a surprisingly robust advance that annualized at a 3.9% growth rate. One of the fastest-growing consumer segments: cell phones hooked into third-generation, or 3G, networks that permit a new level of mobile interactivity. (Cynics refer to 3G as girls, games and gambling since pornography and betting -- not talking or instant-messaging -- seem to be the most avidly used services among men on the phones in Japan.) And a new breed of maverick entrepreneur, such as the rapidly growing chain called Fast Retailing -- a cross between Target and the Gap -- have developed into a powerful economic force. Suddenly, a country that had never seen a Costco (COST, news, msgs), Wal-Mart (WMT, news, msgs), Best Buy (BBY, news, msgs) or The Mens Wearhouse (MW, news, msgs) has found itself ascending into discount heaven.
More importantly, Japan has benefited from Chinas demand for capital equipment and fashionable consumer goods. All the new manufacturing plants need sophisticated machinery, and Japan has been the leading source. Moreover, large Japanese consumer companies have turned their full attention away from the mature economies of the West to focus on the nascent middle class of China. Cosmetics maker Shiseido (SSDOY, news, msgs) recently said it believes a significant portion of its income in 10 years will come from China -- a notion unthinkable five years ago. Already, upwardly mobile middle managers have to wait six months for a Honda Accord in China, according to Matthews Headley, who says that purchasing power is rising faster than anyone expected.
Stocks have anticipated better times ahead for Japan with their tremendous ascent this year, and that is bound to cool off. Its already begun to happen, in fact, as the recent collapse of the U.S. dollar versus the euro and yen led to a sell-off of exporters whose goods may find less demand in the United States at higher prices. Shares of Nintendo (NTDOY, news, msgs), the world's biggest maker of hand-held game players, fell sharply Friday after saying it would post a loss in its fiscal first half due in large part to the strong currency. Nissan (NISANY, news, msgs) also said last week that the yens unexpected muscle would hurt earnings.
However, Bloomberg reported that Finance Minister Sadakazu Tanigaki said Sunday that the government would take "decisive action'' to stem an "irregular'' rise in the yen, suggesting authorities would keep selling the currency to protect exporters. If their new effort to support the yen is anywhere as successful as its move to support stocks in May, stocks and funds may be good to go for a new run soon.
How to participate
Governmental interventions are dysfunctional and, in the long run, doomed unless they kick-start genuine market interest. But if this one works, the most sensible way to participate in Japan going forward is either through an open-end mutual fund such as Matthews Japan, an exchange-traded fund like iShares MSCI Japan (EWJ, news, msgs), or a closed-end fund like Japan Equity (JEQ, news, msgs) or Japan Smaller Capitalization (JOF, news, msgs). Returns have been fairly equivalent over the past year, though the two closed-end funds get higher marks for their shallower lows in the past three years during rough spots.
Most funds own Toyota, Honda, Nippon Telegraph & Telephone (NTT, news, msgs), mobile phone leader NTT DoCoMo (DCM, news, msgs); a handful of financial-services conglomerates such as Nomura Holdings (NMR, news, msgs); and industrial/consumer goods makers such as Matsushita Electric (MC, news, msgs). The latter, owner of the Panasonic brand as well as heavy capital equipment, has restructured mightily in recent years to streamline and economize and is a leader in the move toward Chinese manufacturing.
One offbeat value play could be Nintendo, which owns the backseat of the car in America. Its Gameboy handheld is among the best brands in the world, but its Game Cube home console has struggled against competition from Sonys (SNE, news, msgs) Playstation 2 and Microsofts (MSFT, news, msgs) X-box. Nintendo slashed the Game Cube price to $99 last week in an effort to boost sales, but its competitors are expected to counter by bundling more games with their units instead of cutting prices. The stock has underperformed in recent years, did not participate in the recent rally and now sells at 1997 prices. Headley calls management stubborn and old-fashioned, but, if shares get hammered on a strengthening of the yen over the next few months, they could get cheap enough to provide a margin of safety to deep value investors. (Microsoft publishes MSN Money.)
If by now youre kicking yourself for not buying into Japan when it was on the ropes at this time last year, then consider Korea instead. The new president there is struggling, the economy is a step behind Japan after spending many years well ahead, and a stronger Asian currency regime wont help. But hot money from Japan could rotate there next, and Headley noted that numerous strong companies, such as Kookmin Bank (KB, news, msgs) and SK Telecom (SKM, news, msgs), are trading at single-digit price-to-earnings multiples. Two closed-end funds to consider are Korea Fund (KF, news, msgs) and Korea Equity Fund (KEF, news, msgs).
| Japan: Key stocks and funds | | Stocks/ETFs/funds | Price 10/3 | Volume | | Toyota Motor (TM, news, msgs) | $62.25 | 175,100 | | Honda Motor (HMC, news, msgs) | $20.64 | 726,300 | | Internet Initiative Japan (IIJI, news, msgs) | $7.81 | 1,651,921 | | Matsushita Electric (MC, news, msgs) | $13.21 | 222,900 | | Nippon Telegraph & Telephone (NTT, news, msgs) | $24.15 | 129,400 | | NTT DoCoMo (DCM, news, msgs) | $25.92 | 108,400 | | Nintendo (NTDOY, news, msgs) | $9.85 | 43,900 | | iShares MSCI-Japan (EWJ, news, msgs) | $9.47 | 6,697,100 | | Japan Equity Fund (JEQ, news, msgs) | $6.95 | 98,800 | | Japan Smaller Capitalization (JOF, news, msgs) | $9.84 | 90,600 | | Matthews Japan (MJFOX, news, msgs) | $13.05 | |
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| Korea: key stocks and funds | | Stock/fund | Price 10/3 | Volume | | Kookmin Bank (KB, news, msgs) | $35.08 | 257,300 | | SK Telecom (SKM, news, msgs)) | $18.36 | 423,800 | | Korea Equity Fund (KEF, news, msgs) | $4.33 | 8,300 | | Korea Fund (KF, news, msgs) | $16.55 | 120,100 | | Matthews Korea (MAKOX) | $4.26 | |
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Fine Print
Ive started to post lists of stocks mentioned in my columns -- and subsequent returns -- on my personal Web site. The archive is not complete, but it will eventually stretch back about a year. You can check it out here. . . . For news on Japan, visit these Web sites: NewsonJapan.com; The Japan Times; Asahi.com; and Nikkei Net Interactive. . . . Go figure. The most prosaic name in my list of momentum stocks for a bull run, Oxford Industries (OXM, news, msgs), is up the most since Sept. 24. It was one of the few that did not even hiccup during the recent sell-off. Based in Atlanta, the company designs, makes and wholesales private-label apparel as well as items tagged with Tommy Hilfiger, Nautica, Geoffrey Beene, Slates, Dockers, Oscar de la Renta and Tommy Bahama labels. . . . Candy and collectibles maker Topps (TOPP, news, msgs), mentioned as a value pick by Bruce Sherman in my 12 contrarian picks column on Sept. 10, is up about 12% since on the strength of a solid earnings report and continued targeted acquisitions. In the middle of last month, Topps said it had entered into an agreement to buy assets from The Foreign Candy Co., the Iowa maker of kid favorite Warheads sourballs.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, Jon D. Markman owned or controlled shares in the following equities mentioned in this column: Toyota.
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