The empire of the rising Nikkei.
Japan has begun to seriously scare me. My readers and friends in town know well that I wrote successive columns in late-2012 and early-2013, recommending investors go long the Nikkei. The Dow index and Japanese auto exporters while shorting the yen against the dollar. However, the Nikkei Dow was 8,000 and dollar-yen was 76 when I first described the once in a generation money-making potential that Abenomics offered after the tragedy of Fukushima, the return of the LDP to power and the uneasy rise of China. However, the Nikkei Dow is now 17,400. Dollar yen is 118 and I am scared stiff about what happens next in the Empire of the Rising Sun.
The 1.6 per cent GDP fall in the third quarter means Japan is now in recession. Earnings growth falls when economies contract for six months. Yet Japanese EPS growth since 2012 has gone ballistic, thanks to the biggest fall in the yen since the Plaza Accords. The $30 fall in crude oil prices and the Bank of Japan's "shock and awe" money printing is also hugely bullish for Japanese exports. Yet Japanese equities have now turned dangerously volatile. Japan is not expensive, compared to the stratospheric valuations of the US, India, Europe and GCC markets.
Does Japan deserve to trade at a valuation discount to the US? Yes. Its "keiretsus" are not managed to maximise shareholder value. It boasts no Silicon Valley or biotech sector. Nikkei Dow RoE is one-third American equities RoE at a mere five per cent. Japanese corporate governance is, well, opaque. Japanese politics, regulators and bureaucrats cast a malign shading on its financial markets. Structural reform (Abe's third arrow) is lackluster. Now Japan is in recession, Abe has postponed the consumption tax and now called a snap election. Japanese capitalism can seriously destroy investor wealth, as any fund managers who went long the Nikkei at 38,000 in 1990 learnt during the subsequent twenty two years.
Shinzo Abe will be re-elected since Japan's vote banks are notoriously mobile and party agnostic. But will the Ministry of Finance and vested interests in Japan Inc allow Abe to tear apart Japanese business with his reform agenda? Particularly in sensitive industries such as pharmaceuticals/health care, power/electricity and e-commerce? No. Has Abenomics increased dividend payout ratios and share buybacks? Yes. This is the reason the Nikkei Dow has more than doubled since October 2012, a spectacular bull run chronicled ad infinitum in Khaleej Times. Macro crystal ball-gazing is an intellectual challenge and an exquisite prism to make sense of the world.
So am I a true believer in the secular bull case for the Nikkei Dow? Hai. Would I buy now? Absolutely not. Corporate reform in Japan may well trigger a valuation rerating but a glance back at the economic history of Japan from the Tokugawa Shogunate and the Meiji Restoration to the tenures of Prime Ministers Nakasone and Koizomi tell me that this ancient society will reject radical reformers. We witnessed a 25 per cent fall in Japanese equities last summer when the Bernanke Fed merely hinted at a "taper". Could a global hit in equities hit Japan again? Yes, especially as election risk rises.
It is unwise to short Japan at a time when its central bank is implementing the most aggressive QE programme (relative to GDP) on the planet and its failed Government Pension Fund is poised to increase allocations to equities. I can easily see dollar yen trade at 126-128 sometime in 2015. Earnings growth will be nothing like 2013 but a respectable 15 per cent. Japan is cheap, in a historical context, at 1.3 times book value and 12.8 times forward earnings. So it makes total sense to buy Japan the next time Wall Street has a risk spasm. I am convinced that the Nikkei Dow will trade above 2000 before next June. However, it would be great if investors in Dubai get a chance to revisit Marounuchi at Nikkei 15,000. The election will be the ultimate referendum on Abenomics. Japan could well be the winner developed market of 2015, the centenary of Gallipoli, the double-centenary of Waterloo.
Researched and compiled by Matein khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: firstname.lastname@example.org
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