Basic Recap of the Situation in Japan

The Globe and Mail runs over the situation in Japan in this article. The article doesn't provide much in the way of investing ideas but it does present the mood regarding Japan. The article is Canadian so anyone investing in Japan really got clobbered last year.

For frustrated Canadian investors, the land of the rising sun is still dark. Poised as last year's comeback kid, Japanese equities plunged 18.7 per cent in Canadian dollars compared with a 7-per-cent dip for global equities.

You can't blame the neighbourhood - Chinese equities doubled over the same period, and while the Chinese economy steamed ahead by 10 per cent, Japan's gross domestic product growth plodded along at 1.3 per cent.

For a large cap developed market index to drop 18% is huge. Of course a lot of the loss is from the Canadian dollar appreciation, but it was still a poor situation.

"The Bank of Japan's monetary policy does not seem to have much impact on the economy" says J.P. Morgan chief economist and former Bank of Japan official Masaaki Kanno from his Tokyo office. "Even if the BoJ had maintained the zero rate policy, Japan's economic performance would not be much different from what we are seeing now."

Part of the problem for Japanese central bank is that a lot of their policies result in capital fleeing Japan (eg. the infamous Yen carry-trade). The non-shareholder-oriented Japanese business culture also makes it difficult for investors to embrace Japan. As I and others have pointed out numerous times, Japanese companies have very poor ROE. Here is a speech given by Warren Buffett remarking on the low ROEs in Japan (I think the speech was given in 2000 or thereabouts). The thing that I never knew until listening to this speech was that ROEs were low even during the boom period.

The opinion on Japan is divided among value-oriented or contrarian investors. Here is one strategist who is bearish on Japanese equities:

He [Paul Rodwell of AGF International Advisors] says Japan has lost its technological leadership and there's no sign it will ever recover. "The long-term growth rate is probably only around 1.5 per cent and by developed-economy standards, that's really quite disappointing".

Even after last year's market decline, Mr. Rodwell views Japanese equities as "simply too expensive." His meagre Japanese holdings include what he considers contrarian value plays such as Mitsubishi Corp., Nippon Mining Co. Ltd. and Nippon Oil Co. Ltd.

There are others who see some opportunities in Japan:

International equity funds at the opposite end of the spectrum include the Mackenzie Focus International Class fund, which held its loss last year to 1.4 per cent with a Japanese equity weighting of nearly 30 per cent. The fund is managed by legendary value investor Peter Cundill, who has spent the past few years acquiring Japanese equities for his Mackenzie-managed funds.

Mark Grammer's Mackenzie Universal Global Growth fund lost 1.5 per cent last year with a smaller Japanese equity weighting of 14 per cent. He also co-manages the Mackenzie Focus Japan Class fund, which sunk 20.5 per cent with an 87-per-cent weighting in Japanese equities. "I am concerned that Japan has steadily lost relevance as a global superpower," Mr. Grammer says.

He says more than one-third of Japanese equities are trading below book value and there are still gains to be made for investors with patience. "Japan is very good for value plays," he says. Stocks in his portfolio include Nintendo Co. Ltd., and diesel filter makers NGK Insulators and Ibiden.

As for me, I'm looking at Japanese small cap stocks. If I get any good ideas, I'll post them here. My goal is to find one in a sector like consumer staples or consumer discretionary, with a decent ROE and trading below book value. The way I'm going about it is to look at Japanese ETFs or indices (like the S&P Nomura small cap index) and then see if there are English websites for those companies I find interesting.