How sustainable is the æbuy JapanÆ story?
Hiroshi Motoki: Japanese equities were an unattractive market for a long time, falling 80% from the 1989 peak. Rebounds were simply opportunities to sell. In the minds of investors, Japan is a market to avoid. And sure enough, last year the market rebounded since 2003 with the Nikkei rising from 8,000 to 17,500, only to correct again.
But this time itÆs totally different. In the 1990s, the post-bubble era, Japan experienced continual declines in real-estate prices. Residential property prices were cut in half. And the banksÆ balance sheets were damaged, consumers were hurt.
Today, however, both of these problems are over. Real-estate prices are now appreciating. Some prime locations in Tokyo have seen prices rise by 20%. At a national level some prices are still falling but these are now hitting bottom and will eventually recover as well. Meanwhile, the banksÆ financial crisis is over. TheyÆre solvent and making money again.
Overall, the macro statistics have all turned around. The first quarter of 2006 saw GDP growth at 3.8% and unemployment fell to 4%, while industrial production has increased and deflation has turned into mild inflation.
So does that make this a buying opportunity?
Yes. The correction was not predicting a crash. New investors wonÆt make quick money this year û after all, the Topix rose more than 50% since the beginning of 2005. Now itÆs not about the index but about picking stocks and researching companies.
What kind of stocks are you looking to add?
We donÆt emphasise big companies like Toyota or Canon. ThereÆs no new information about these companies. ThereÆs 30 sellside analysts chasing them. We try to add value in the small- and medium-cap area.
Are there broad themes where you find attractive companies?
We like themes related to energy, capital expenditure and specialised materials like titanium and silicon wafers. Japanese producers have huge pricing power and significant global market share. Look at titanium: the global demand for replacing aircraft, both commercially and militarily, is driving demand. The raw material is plentiful but the added value is in the refining, and few companies can do it.
IsnÆt the market a bit expensive, though?
Valuations vary from high to reasonable. The average price/earnings multiple is 18x, which is at a premium to US and European markets, but only by a little bit. As a stock picker, we analyse companies to find out where to find growth, whether there are surprise factors, or whether the market has already priced in all possible outcomes. Titanium is a well-known story but profits growth will, we think, surprise the market.
So why should investors find Japanese equities attractive?
Companies are behaving conservatively. They are financial stable and their individual risks are low. The macro environment is strong. Exports once accounted for everything but the economy is now more balanced against domestic growth. Companies have restructured without spending on capex for years, but thatÆs beginning to change to address some of the bottlenecks that have emerged. Savings are high, at around $120,000 per capita, with most of that in the hands of the elderly, who must now spend more or put more into capital markets.
WhatÆs the marketÆs potential now?
We expect over the next 12-18 months, the Nikkei to hit around 18,000, and Topix to be around 1,800, with earnings multiples averaging 20x. We donÆt really know when this will happen û it was the consensus forecast for 2006, but looks less likely now in that timeframe.
What are the risks to that outlook?
In the long run, demographics and aging. In the medium term, over the next few years, itÆs how Japan deals with its huge public-sector debt, which is now 180% the size of GDP; a consumption-tax increase looks likely, maybe in 2009. In the short run, the risks are tighter monetary policy and the threat of stretched housing valuations in the US impacting consumption. But so far results out of the US are good, and earning revisions remain more on the upside.
Is China a risk factor? China was credited for jump-starting JapanÆs economic recovery.
The United States remains the biggest factor when it comes to Japanese exports, but yes, ChinaÆs market is also important. I think it will remain okay at least until the Beijing Olympics in 2008. The longer-term risk is probably politics and just how stable China remains.