The 9.0-magnitude earthquake that devastated Japan is likely to leave buying opportunities in its aftermath — even as certain economic indicators point in the opposite direction
The 9.0-magnitude earthquake that devastated Japan is likely to leave buying opportunities in its aftermath — even as certain economic indicators point in the opposite direction.
“We haven't seen Japanese stocks this cheap in a long time,” said Virginie Maisonneuve, head of global and international equities at Schroder Investment Management Ltd.
“They looked quite attractive before [the earthquake], and prices became just absurd afterward. We think it's a fantastic buying opportunity,” Ms. Maisonneuve said.
Although Schroders is generally underweight Japan relative to global benchmarks, portfolio managers have continued reducing the underweight position within 2 percentage points of the global benchmarks used in various active equity strategies. By comparison, Schroders was as much as 6 percentage points underweight prior to the 2008-09 financial crisis.
Schroders managed about 26.6 billion pounds ($43 billion) in global equities strategies as of March 31, part of its 201.4 billion pounds in total assets under management.
The consensus view places much uncertainty in the short term because of recovery efforts and in the long term because of unresolved structural problems. But the value of Japanese stocks could have reached a floor in the sell-off immediately after the March 11 quake and tsunami, and are poised for a sustained rebound, managers said.
Furthermore, the Japanese equity market generally benefits from expected global growth because of its export-led economy and also stands to gain if the dollar strengthens against the yen, as some predict.
However, others argue that the low pricing clearly reflects problems that have left Japan as arguably one of the most unloved stock markets in the past decade: high sovereign debt and low domestic growth, a rapidly growing percentage of people over 65 and ineffective government intervention policies.
Japan's economy has been shrinking in terms of global market capitalization and was overtaken by China last year. Japan's weight within the MSCI All Country World Index, which combines developed and emerging markets, was 7.9% at the end of the first quarter, compared with 10.5% 10 years ago.
“These long-term challenges for Japan mostly have been priced into valuations,” said Patrick Moonen, senior strategist for equities on ING Investment Management's strategy and tactical-asset-allocation team.
On top of that, the earthquake, tsunami and subsequent crisis at the Fukushima nuclear power plant damaged an already weak economy at a time when the global outlook — particularly in emerging markets — is less buoyant and inflation concerns are rising.
LOWEST IN 30 YEARS
Following the recent quake and tsunami, the price-earnings ratio for Japanese stocks was between 12 and 13, and the price-book ratio was about 0.95, according to a report on the market implications of the earthquake published by BlackRock Inc. in March. “Current valuations ... are the lowest seen in Japan in 30 years,” according to the report.
“Just because something is cheap doesn't mean it's a good value,” said Stephen Docherty, head of global equities at Aberdeen Asset Management.
Japan has remained underweight at about the same level within Aberdeen's global, and Europe, Australasia and Far East, equity strategies, which total about 20.6 billion pounds ($33.2 billion) out of total assets under management of 181 billion pounds. Separately, Aberdeen manages about 1.5 billion pounds in a Japan-only equity strategy.
Despite holding “some of the strongest balance sheets in the world,” Japanese companies generally have not been “nimble” in their use of cash to improve returns for shareholders, Mr. Docherty said.
The return-on-equity ratio for Japanese stocks averages about half that of U.S. companies. However, managers including Aberdeen are finding some attractive stocks, particularly those with high overseas earnings potential but also some domestic players benefiting from key demographic changes.
Perhaps one of the most notable challenges for Japanese companies is the rise of the yen, which tends to hurt earnings abroad when converted back to the local currency, managers said. The yen's rise led the Group of Seven industrialized nations to cap the currency's upward trajectory in the week following the earthquake. The yen has since pared its gains.
SHIFT TO NEUTRAL
At the beginning of this year, several managers, including J.P. Morgan Asset Management, ING Investment Management and Natixis Global Asset Management, held an overweight position in Japan, partly due to strong earnings potential but have since reduced their exposures to neutral.
David Shairp, managing director and global strategist within J.P. Morgan Asset Management's Global Market Asset Group, said Japan had the strongest earnings momentum among developed markets before the earthquake hit, but estimates have been revised downward. The outlook for Japan depends on a number of factors, “including global activity and how Japan cyclicals fit into this,” he wrote in an e-mail.
Nicolas Just, head of core equities for Europe and Japan at Natixis, said that the firm will consider returning to an overweight position on Japan if economic indicators improve. Currency volatility was a key factor behind the firm's decision to cut back Japan exposure and remains a key worry.
“Our attitude is very cautious,” said Mr. Just. “Next year may be quite different, with accelerating growth in Japan and decelerating growth elsewhere. “Natixis has 8.5 billion euros ($12 billion) in global equity assets under management out of a total of 530 billion euros in total assets.
Hung Q. Tran, deputy managing director at the Institute of International Finance Inc., an association of 400 financial institutions in 70 countries, said the organization's estimate for Japan's 2011 gross domestic product growth was reduced to 0.5%, from 1%, after the earthquake, but increased for 2012 to as much as 2.5%. The International Monetary Fund also cut Japan's GDP growth forecast to 1.4%, from 1.6%, for this year but increased its estimates for 2012 to 2.1%, from 1.8%.
“We saw very strong [economic] momentum” in Japan at the beginning of the year, said Mr. Tran. “That momentum, combined with additional expenditure when the reconstruction efforts kick in, should provide a very strong outlook” in the next 18 months.
The positive sentiment for 2012 could be derailed by several factors, among them the slower growth in the rest of Asia and other emerging markets, on which Japan is increasingly dependent for exports, Mr. Tran said.
Currency issues continue to overshadow Japan's corporate earnings. Toyota Motor Corp. this month announced a 77% drop in earnings for the quarter ended March 31, not only because of heavy losses as a result of operational disruptions but also due to the high yen.
CURRENCY CONCERNS
Concerns over the currency have been somewhat tempered by the willingness to intervene to stabilize the yen by the Japanese government with cooperation from the Group of Seven, according to Jane Davies, senior portfolio manager for the global investment solutions group at HSBC Global Asset Management (U.K.) Ltd.
HSBC is holding a “moderately overweight position” in Japan in several different strategies, she said.
“We don't think it's time to add, but we've maintained our position in Japanese equities,” Ms. Davies said.
Mr. Moonen also had an overweight position in Japan at the beginning of the year, mainly because of continued devaluation of Japanese equities, strong expected earnings growth and “the somewhat contrarian view that most investors were underweight in Japan.” After the earthquake, however, uncertainty led the manager to reduce his exposure to neutral.
“The value argument has not changed; Japan is still the cheapest developed market,” Mr. Moonen said. “We expect our next move will be to overweight Japan again, depending not only on the economic factors but also the value of the yen.”
At Threadneedle Asset Management Ltd., managers have decided to reduce an underweight position in Japan to neutral, from about 2 percentage points relative to the MSCI ACWI global benchmark when valuations became more attractive following the earthquake.
The firm took the opportunity to buy more stocks in companies in which the manager already had exposure, rather than investing in new companies, said Jeremy Podger, head of global equities at the firm.
Threadneedle actively manages about $3 billion in global equities and about $1.6 billion in Japan-only equities, out of total assets under management of about $100 billion.
“The negative points are out there, but overall, there are few markets of any size” with low correlation to global averages, Mr. Podger said. “Japan is one of them.”
Thao Hua is a reporter at sister publication Pensions & Investments.
