Japan: New Hope or False Start?
by David Ragan, Mawer Investment Management
Next to my desk I have a research report, yellowed with age from February 2, 1988. It’s title: “A Rationale for the Japanese Market’s High Valuation.” The research report goes on for nine pages rationalizing why the Japanese index, trading at a multiple of 56 times earnings, was reasonably priced and that investors should buy. Now some might say the report was right, because had you held the Nikkei index from that day until the end of 1989, you would have been up 64.4%. However, had you held the index from that same day to the beginning of 2013, you would have lost 70% of your capital.
The recent government actions in Japan have flooded the system with easy money, driven up equity values, created an opportunity for the country to exit decades of deflation and economic malaise, and actually given it a chance at growth. This deluge of inexpensive capital has flowed heavily into Japanese equities, with many investors hoping for fundamental changes and higher valuations. Such actions may be creating a speculative bubble in Japanese equities.
Right now, it’s anyone’s guess whether “it’s different this time” because there have been numerous false starts over the years. Japan has to overcome a cumbersome business culture, high taxes (the corporate tax rate is 38.01%), and significant government debt (recently overtaking Zimbabwe for the #1 spot at 214% of GDP). To make matters worse, Japan is the textbook case for bad demographics given their aging population and a restrictive immigration policy. On the other hand, businesses are sitting on significant cash reserves which could either be deployed intelligently or given back to shareholders. And if their current monetary policy succeeds and inflation takes hold, the Japanese consumer may finally re-emerge and start spending.
As bottom-up investors, we always concentrate our efforts on the companies themselves – do they create wealth, are they well-run, and can we buy them at a reasonable price? Unless we can find investments that meet these tenets, we don’t invest. This process keeps us focused and has repeatedly helped us avoid traps. Given that many companies’ share prices have already priced in material positive changes in the Japanese business environment and an improvement in profitability, we have trouble finding investments in Japan that are attractive. We continue to scour Japan (and the rest of the world) for ideas, but we refuse to speculate that we can trade better than the market; rather, we try to invest better.
Perhaps investment strategist, Dylan Grice, said it best when he quipped, “I’m interested in the possibility of building a profitable portfolio which is robust to my ignorance.”
David Ragan
Copyright © Mawer Investment Management
