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Japan, the Yen, and Takefuji

General Thoughts on Japan

As I have remarked many times before, I am planning to focus my future investment research on Japan. Until I do more reading, I won't know for sure but right now it fits my profile and strategy. It is out of favour (can you believe it is actually negative for the year in US$ terms?), transparent (easy to get information for the large companies, and corporate governance is improving), relatively low valuations (on a P/E basis it is not cheap but if you think earnings are depressed then it isn't so bad; on price/book it is pretty attractive), etc. Not sure when I'll get to it but my goal is to read these two books in the near future: Japan on the Upswing, and Japanese Money Tree. Anyway, here are some articles I read on Japan recently (some of these articles are old and I only read them now)...

Barron's had this run down of the attractiveness of Japan. I liked the article but my thesis for investing in Japan is to avoid the 'China play'. I'm bearish on emerging markets and although I have been wrong all year long, I am staying away from anything dependent to them. The Barron's article lists a bunch of companies who are export-oriented and will get hit if China or USA slows down.

Sparx Group offers Japan mutual funds and provides some good commentary on Japan. Also if you want a quick glance at some economic indicators for Japan and other East Asian countries, you can find them here.

The most undervalued part of the Japanese equity market seems to be the small-caps. As is generally the case everywhere, when things are in favour small caps outperform and when everything is bearish small-caps get clobbered. The chart below shows illustrates how cheap small caps look on the surface in P/E terms:

(source: Can Japan's Small Caps Stand Tall Again?, Chester Dawson,
Sparx Investment & Research, September 2007)

Small-caps with a P/E of around 12 versus large-caps at 18 is a huge gap. Although small caps are risky, if you think about the fact that they tend to have much higher growth rates, that is an amazingly low multiple.

The problem for small investors is that it is hard to get English information on the small caps. Some of them also trade on the smaller stock exchanges, like JASDAQ, and I'm not sure if I can even buy them through my brokerage. There are small-cap CEFs and ETFs in the US that you can use (like JOF) but unless you are making a sector-wide bet that is not so attractive. I would rather attempt to pick one or two stocks. The small-cap sectors that I find attractive are retailing, food, and real estate.

Yen Carry-trade Keeps Unwinding

The Yen carry trade keeps unwinding. There is an extremely high correlation between the Yen and the broad markets. I know I keep posting about the same thing but this has massive consequences. American investors, in particular, should start posting gains in US$ terms in the future even if the Japanese stock market doesn't go anywhere (as long as it doesn't drop a lot). For people like me in Canada, I haven't seen much positive impact since the Canadian dollar is still strong against the Yen. However, if I start shifting assets into Yen-denominated assets over the next few years, I will likely see some positive return simply from the Yen strength.

The strength in Yen is one reason I would be wary of Japanese exporters. Most people who invest in Japan seem to be overweighting the exporters but it may be time to look at those that benefit from a strong currency, such as importers, retailers, restaurants, real estate, and so forth.

As Shu Abe of Sparx Group comments here, the strengthening of the Yen--if it actually is for real (we've had many fake rallies many times in the past)--may finally kickstart the consumer. The Japanese economy has been improving for the last 5 years but that is primarily due to exports. This article from The Economist has a good run-down of the present economic status of Japan. If the consumer ever wakes up, Japanese deflation will end; if the consumer doesn't wake up, Japan is going to go into a recession if USA does.


I am a shareholder in Takefuji (down about 20% since purchasing early this year) but things are improving. So far, personal bankruptcies are holding up well:

(source: Takefuji)

That's just one measure but I sort of look at that to see how individuals are coping in Japan. The business still keeps deteriorating but at least the big write-offs are out of the way.

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