Japan Price-to-Assets Makes for Cheapest International Stocks

Jan. 25 (Bloomberg) -- Not even the slowest economic growth in the industrialized world or deflation can keep Byron Wien, David Herro and John Alkire away from Japanese equities.

Wien, the Blackstone Group LP adviser who predicted last year’s rallies in stocks and oil, says Japan shares are his favorites. Harris Associates LP’s Herro, Morningstar Inc.’s international manager of the decade, says stocks at the cheapest ever relative to assets will gain even if the economy stagnates. Alkire of Morgan Stanley Asset & Investment Management is betting low debt levels will spur an advance that beats the U.S.

Japan, the world’s second-biggest equity market, is up 3.7 percent this year as measured by the Topix index, the most among the world’s 10 largest economies. Overseas investors pumped almost $13 billion into Japan during the two weeks ended Jan. 15, the most since 2004. Companies trade for an average 1.2 times book value, almost half the valuation for the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.

“My best investment idea is Japan,” said Wien, 76, a former market strategist at Morgan Stanley and at hedge fund Pequot Capital Management Inc. who predicted the end of the technology bubble in 2000. “The Japanese market looks relatively attractive assuming the earnings come through, which I think they will.”

More investors are looking at net assets instead of earnings after the economy posted its lowest production since 1991 in the third quarter and stagnant profit growth left companies in the Topix trading at an average 37 times estimates for this year’s income. The price-to-earnings ratio is the highest among the world’s 10 biggest markets.

1989 High

The index fell 2.6 percent last week to end at 940.94. While the Topix remains 67 percent below the high reached on Dec. 18, 1989, investors profited in nine of the past 20 years, including a 58 percent gain in 1999 when the S&P 500 rose 20 percent.

Since the end of 2005, the Topix has fallen 43 percent, compared with the MSCI World Index’s 8.6 percent drop, as successive prime ministers including the current Yukio Hatoyama battled deflation and faltering growth. Bank of Japan Governor Masaaki Shirakawa said on Jan. 18 that he will keep borrowing costs near zero to help end the worst postwar recession. Hatoyama unveiled a 7.2 trillion yen ($80 billion) stimulus package last month.

Wien, Herro and Alkire’s predictions are based on valuations instead of economic prospects. Wien favors export- related companies, technology makers, and drug and cosmetics suppliers. Gauges of automakers and electronics companies in the Topix have climbed 11 percent and 6.2 percent, respectively, in the past three months, more than the broader index’s 4.3 percent advance.

Priced In

“Japan doesn’t have to be a strong economy to attract investor interest,” Wien said. “Things aren’t getting good there, but they’re not getting bad either. The bad news is diminishing.”

Companies in the Topix are projected to turn profitable in 2010 after a combined loss of 40 yen per share in the past 12 months, according to data compiled by Bloomberg. The Topix’s book value is 33 percent below its average dating back to 1993 of 1.8 times, according to data compiled by Bloomberg.

“Japan is extremely cheap on fundamentals,” said Herro, the chief investment officer for international equities at Harris, with $55 billion in assets. “When you combine the two concepts of low price and high quality to get a value proposition, especially if we see a movement towards more sustainable operating profitability by corporate Japan, this could be one of the best-performing markets over the next couple of years.”

Toyota, Canon

Herro bought shares of Toyota Motor Corp., the world’s largest automaker, and Canon Inc., the biggest camera manufacturer. Analysts surveyed by Bloomberg project Toyota will return to an operating profit this year, while Tokyo-based Canon’s may climb 64 percent from 2009.

Japanese equities underperformed industrialized nations since the MSCI World Index of 23 developed countries reached a record on Oct. 31, 2007. The fallout from the global recession has left the MSCI World 32 percent below that peak, compared with 30 percent for the S&P 500 and 42 percent for the Topix.

Alkire, the chief investment officer for Morgan Stanley Asset in Tokyo, says Japanese stocks may beat the U.S. and Europe in 2010 as falling expenses and low debt bolster profits. Forty-three percent of Japanese companies have no borrowings, compared with 18 percent in the U.S. and 17 percent in Europe, Alkire said in a presentation to pension funds in Tokyo.

‘Never Say Never’

“For most of the past year, foreign investors said, ‘Never buy Japan,’” said Alkire, whose firm oversees about $39 billion. “But this year, I say, ‘Never say never.’ Global markets will likely focus on Japan.”

Standard Life Investment Ltd.’s Frances Hudson isn’t as bullish because price drops may erode profits and hamper the recovery. Consumer costs fell 1.7 percent in November from a year earlier, the ninth month of declines. Japan has deflation for the first time in three years, according to the government.

“I wouldn’t write off the whole of Japan, but I would struggle to find anyone feeling positive on the domestic situation,” said Hudson, who helps oversee $197 billion at Standard Life in Edinburgh and advises staying “very light” on Tokyo-listed shares in global funds. “The government doesn’t seem to be able to make any headway in reforms. Neither in stimulating consumer spending or ending deflation.”

Speculation drove the Nikkei 225 Stock Average to a record 38,915.87 on Dec. 29, 1989. What followed was the popping of an asset bubble and a plunge in stock and real-estate values in what became known as Japan’s Lost Decade.

Worst Drop

The Nikkei has lost 73 percent from that peak, the worst performance of the world’s major markets. Japan’s nominal gross domestic product rose 23 percent between 1989 and 2008, while the U.S. increased 163 percent, according to data compiled by Bloomberg.

Japanese gross domestic product shrank to an annualized 471 trillion yen in the third quarter, the lowest level since 1991, according to Cabinet Office figures. It’s forecast to expand 1.4 percent in 2010 after a projected 5.3 percent contraction last year, according to the median estimate of economists surveyed by Bloomberg. That’s less than the 2.7 percent growth the World Bank in Washington is predicting globally.

U.S.-based funds that invest in Japanese equities attracted new money equal to 2.7 percent of total assets in the week ended Jan. 13, the most inflows since October 2005, according to data from EPFR Global in Cambridge, Massachusetts, and Frankfurt- based Deutsche Bank AG.

Weakening Yen

Money is returning as investors speculate Finance Minister Naoto Kan will bolster exports by weakening the yen, which touched a 14-year high against the dollar on Nov. 27.

Kan said Jan. 7 on his first day in office that he would welcome a weaker currency, compared with his predecessor, Hirohisa Fujii, who opposed “easy intervention.” The yen has dropped 5.9 against the dollar since Nov. 27, while the Nikkei average has rallied 17 percent.

A weaker currency will spur a rebound in stocks, according to Seiichiro Iwasawa, chief strategist at Tokyo-based Nomura Holdings Inc., the country’s largest brokerage, who predicted last month the Topix will climb to 1,200 by the end of 2010.

Operating Profit

A five-yen appreciation against the dollar that holds for a year would trim 0.2 percentage point from gross domestic product, according to Tatsushi Shikano, senior economist at Mitsubishi UFJ Securities Co. in Tokyo. Every 1 yen drop by the Japanese currency against the dollar raises Toyota’s operating profit by about 30 billion yen and Honda Motor Co.’s by about 12 billion yen, according to figures supplied by the automakers in November.

Toyota soared 13 percent in December after plunging 14 percent the previous three months. The Toyota City, Japan-based company gets 32 percent of revenue from North America. Tokyo- based Honda, Japan’s second-largest carmaker, jumped 15 percent in December after a three-month, 8 percent drop. The company makes 81 percent of its sales from abroad.

The “change in attitude by the government is significant,” said Phillip Schwartz, a New York-based director at ING Investment Managers who helps oversee $1.3 billion and has been buying Japanese exporters. “Having been underweight for so long, fund managers fear being left out.”

To contact the reporters on this story: Alexis Xydias in London at axydias@bloomberg.net; Shani Raja in Sydney at sraja4@bloomberg.net.
Last Updated: January 24, 2010 10:01