Can you make money in Japan?
By Michael Wood-Martin, Henderson Horizon Fund – Japanese Equity Fund

Those who cannot remember the past are condemned to repeat it, but in Japan's case remembering the past is easy, escaping it is the problem. This is the land of the lost decade where past mistakes refuse to go away.

The myth surrounding Japanese equities is that they have been a disaster case over the last two decades. The truth is rather more compelling. In fact the fortunes of the Japanese equity market have tended to be closely correlated with economic activity in the rest of the world.

The last twenty years have seen half a dozen troughs for the global economy (1992, 1995, 1998, 2001, 2003, 2005 and potentially 2009), followed by periods of sustained growth. In five out of the six periods of recovery Japanese stocks have been participants in the bounce-back, without ever finding for themselves a platform for prolonged growth.

On these occasions the Japanese Topix Index has risen sharply, making gains of between 40%-80% in the ensuing period. The exception was the run up to the war in Iraq, when Japan, along with other stock markets, failed to respond to a recovery in economic activity. On the downside, investors have felt considerable pain once economic activity subsided. The subsequent falls have been just as steep, leaving investors back at square one or worse.




This goes some way to explaining the frustration that most investors feel towards Japan. Its equity market has remained stuck within a frustratingly limited trading range, unable to break the cycle.

Can you make money in Japan? Yes, provided you know when to get in and when to time your exit. If you’d held on over a 20-year period there’s high probability that you would have lost money.

Investors could therefore be forgiven for adopting a more opportunistic approach: get in at the bottom, watch for the warning signs to mount up and get out as economic data crescendos.
At present Japanese markets appear to have reached another bottom. Equities are back to the levels seen in 2003 or, going further back, the early 1980’s. However, this time companies are in far better shape than in previous downturns and therefore represent more of a bargain.

Chastened by previous balance sheet blowups, the corporate sector has re-emerged much stronger. Directors are far more focused on shareholders, increasing dividends to keep investors happy and increasing share buy-backs as a means to boost corporate value.

Another dissimilarity from previous downturns is also emerging. Whereas the 1990s were dominated by deflation, characterised by a contraction in asset prices, bank lending in Japan is currently on the increase.

In March lending rose 3.6% year on year and by 4.2% year on year on an adjusted basis (accounting for forex, loan losses and securitisations). The credit crunch has helped to an extent. As some credit markets have been closed for business corporates have been forced to go directly to banks for borrowing. Neither have Japanese banks been as badly caught out by the global credit crunch as have their western counterparts. State intervention has been minimal and capital injections have been offered but not generally required. Dare we dream but Japan may be entering a normal credit cycle.

Fiscal spending is now the norm in most major economies, but could have greater traction in Japan than in other countries. The Japanese government can focus their attention on supporting growth areas that other countries are too preoccupied with bailouts to address. For example, small and medium sized enterprise packages, government equity purchase schemes and a direct influence on the economy by way of consumer tax breaks aimed at boosting the housing market may surprise even ardent sceptics on the economy.

If you take the view that global recovery is on its way (which is by no means a certainty but something that Japan's export-based economy is relying on) the fundamentals point to Japan staging a strong rally of its own. Whether it is now better placed than before to break free and be the agents of its own secular bull market remains to be seen.


Bull points
▪ Corporate Japan in far better shape than previous downturns
▪ Tax breaks to provide welcome boost for the housing market

Bear points
▪ Foreign investors still wary – even at current valuation levels
▪ Recovery heavily dependent on global demand for exports

About the Henderson Horizon Fund – Japanese Equity Fund
▪ Concentrated portfolio - typically 30-40 holdings
▪ Top 10 holdings usually account for more than 40% of the portfolio
▪ Flexibility across size and sector bands
▪ Normally fully-invested and currency unhedged

Current investment strategy
▪ 33 stocks with minimal cash level
▪ Focus on domestic activity rather than overseas economies
▪ Overweight in banks, real estate and services for sector allocation
▪ No exposure to shipping, steel, machinery or commodities as a result of concerns over the rate of expansion in the Chinese economy

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