U.S. Investors See More Gains Ahead as Japanese Stocks Jump
Foreign money is pouring into Japanese stocks again, convinced that the Japanese economy’s four-year slide is over and that a robust corporate profit turnaround is imminent.
Many foreign buyers also are betting on another, perhaps more important turnaround: a change in Japanese investors’ gloomy view of their market, which has left most of them watching unimpressed on the sidelines as the gaijin (foreigners) snap up Japanese shares.
The Nikkei-225 stock index has soared from 17,417.24 at year’s end to 20,973.59 as of Tuesday, a 20% gain that makes the Tokyo market among the world’s best this year. In recent days the Nikkei has been particularly strong, breaking above the 20,000 mark to a nine-month high.
Optimism is running strong among many American portfolio managers, who believe that the Japanese economy is finally bottoming and that Japan therefore offers an opportunity to buy stocks on the ground floor of a recovery. Obviously, any investor who missed loading up on U.S. stocks two years ago, while the U.S. economy languished, doesn’t want to make the same mistake twice.
Barton Biggs, the influential investment strategist for Morgan Stanley & Co., recently told clients that “the Japanese market is a buy right now.”
Biggs’ case is that Japan’s many ills--including a floundering political system, collapsed corporate earnings, a strong yen and horrendous hidden real estate loan losses at banks--are already so well known to investors that they must be mostly discounted in stock prices.
“What isn’t discounted is that Japan is still a huge, powerful economy with a formidable business class running world-class companies located in the center of the fastest growth area of the world,” Biggs told clients in a May 11 report.
Strictly by the numbers, Japan still looks sickly. Real economic growth, 4% in 1991, plunged to 1.5% in 1992 and was a negative 0.1% in ’93.
The problem last year was largely internal: Japan’s wealthy consumers sharply reduced their spending as the country’s major corporations launched restructuring efforts (including deep cuts in capital spending, and some layoffs) to cope with weaker global demand for Japanese exports.
In short, 1993 was the year in which corporate Japan finally acknowledged that the glory days of the 1980s’ export era--when Japan stood unrivaled--were finished. The nation’s political machine also broke down last year, ending what had essentially been 38 years of one-party rule.
The price of corporate and societal restructuring hasn’t been paid in full: Morgan Stanley expects only 0.7% real growth in Japan this year, far below expected U.S. growth and even below what struggling Europe should be able to muster.
But stock markets look ahead, and that’s what is happening now, say the Japan bulls. Merrill Lynch & Co., for example, is telling clients that Japanese corporate earnings could rocket 35% next year from this year’s depressed levels.
Morgan Stanley’s Biggs expects that revived domestic demand and faster export growth will lead to 5% to 6% economic growth in Japan in 1995-1996. “When that happens, profits should explode,” Biggs contends.
Even so, many investors would argue that Japanese stocks already reflect 1995 earnings gains, and more. The Japanese market’s price-to-earnings ratio is an astronomical 70 now, based on estimated 1994 earnings per share. Even cut in half, the Japanese P-E would be 35, far above the 15 to 20 P-Es of most world markets.
The bulls contend that the P-E argument isn’t important, and not just because Japanese stocks have always sold for high P-Es. Adjust for accounting differences and look at real, cash earnings of Japanese companies, and many Japanese stocks appear quite reasonably priced, says John Hickling, one of Fidelity Investments’ senior international managers.
By Morgan Stanley’s figuring, Japanese stocks now sell for 7.8 times estimated 1995 cash earnings, versus 8.3 times for U.S. stocks.
Hickling, who manages Fidelity’s Japan stock fund and Overseas stock fund, says “a lot of the (Japanese) stocks I own sell for less than 10 times 1994 cash flow,” which is cheap if you consider how depressed profits still are this year, he says.
“I think the Japanese market looks terrific,” Hickling says, and he’s focused in particular on industrial giants such as Toyota. “You just have to look at what they’ve done to their cost base” to see rich future profit potential there, he says.
William Stack, manager of the Lexington Global fund, also believes that Japan’s leading industrial firms are poised for stunning turnarounds. “One of my strongest investment convictions today is Japanese cyclical stocks,” says Stack, whose fund owns issues such as Toyota and Honda Motor.
Yet beyond the obvious potential pitfalls in the bullish case on Japan--another dive in the economy, or a further strengthening of the overvalued yen--there’s one glaring problem: The Japanese themselves aren’t buying stock.
Still traumatized by their four-year bear market, Japanese regard the latest market surge as the work of “silly gaijin ,” says Jamie Rosenwald, whose Redondo Beach-based Rosenwald Capital Management has long been active in Japan.
Rosenwald is going to Japan next week, specifically to look for hints that cash-rich Japanese institutions are ready to move back into stocks. If he can’t find evidence of a change in sentiment, Rosenwald admits he will have to reconsider his bullish view of the market. After all, he notes, the Nikkei bounced from 16,000 to 20,000 a year ago, only to slump again in the fall.
If domestic investors join in, the Nikkei could hit 25,000 in a hurry, Rosenwald says. Without them, “This rally could fizzle real quickly,” he warns.
Michael Lindsell, Tokyo-based manager of the GT Global Japan stock fund, says there are some signs that the Japanese want to buy stocks again, but that most investors there are wary--himself included. “I am pretty suspicious about a wholehearted (economic) recovery,” he admits.
The question thus is, who has a better view of Japan’s future--the downtrodden Japanese, or the outsiders looking in?
Hot Streak
Tokyo stocks have rallied sharply this year, and now are at their highest levels since September.
Nikkei-225 stock index (biweekly closes except latest) 1993 June 11: 20,501 June 25: 19,659 July 9: 19,877 July 23: 19,735 Aug. 6: 20,358 Aug. 20: 20,607 Sept. 3: 21,116 Sept. 17: 20,391 Oct. 1: 20,283 Oct. 15: 20,174 Oct. 29: 19,703 Nov. 12: 18,494 Nov. 26: 16,726 Dec. 10: 17,257 Dec. 24: 17,446 1994 Jan. 7: 18,124 Jan. 21: 19,307 Feb. 4: 20,301 Feb. 18: 18,960 March 4: 19,966 March 18: 20,469 April 1: 19,112 April 15: 20,165 April 29: 19,725 May 13: 20,271 May 27: 20,777 TUES.: 20,973.59
