Tokyo isn’t known as a city of bargains, but for US investors, everything in Japan is on sale.
“I’m in Tokyo right now, and it feels like Italy in the 1990s during the lira [currency crisis],” says manager Shuntaro Takeuchi of the Matthews Japan fund (ticker: MJFOX). “Everything is unbelievably cheap.”
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The Japanese yen fell to a 20-year-plus low against the US dollar this month, making Japanese-made goods and stocks cheaper in US dollar terms. It’s the reason that the Tokyo Stock Price Index,
or Topix, is down only 7.2% in 2022 in yen terms, but the popular iShares MSCI Japan exchange-traded fund (EWJ), which is denominated in US dollars, is down over 20%.
Yet there are good reasons to find Japan funds attractive now. While global stock markets have tumbled on inflationary concerns, Japan has struggled for decades with deflation. Some money managers see the prospect of Japanese inflation as good news.
In Japan, “prices came down partially because they were extraordinarily and unsustainably high in the 1980s,” says Drew Edwards, manager of the GMO-Usonian Japan Value Creation fund (GMAHX). “But that put in place this deflationary spiral that we’ve seen now over the past three decades.” The mind-set among Japanese consumers and executives, he says, was “Why would I buy a house today when it’s going to be cheaper next year?” Consumers and companies hoarded cash instead of spending, and the economy stayed sluggish.
Now, because of rising oil prices and pandemic supply-chain logjams, prices in Japan are finally rising, and this should stimulate domestic growth. While there has been some political pressure on the Bank of Japan to raise interest rates to combat inflation, many say that won’t happen. “Inflation continues to be relatively low in Japan, around 2%, which is the Bank of Japan’s target,” says Daniel Hurley, a portfolio specialist at the T. Rowe Price Japan fund (PRJPX). “That’s why they’ve been saying, ‘We’re not changing our monetary policy.’ ,
Even so, Japanese stocks have been behaving as if rates have been rising. Normally, when rates go up, expensive growth stocks decline the most because they promise profits in the distant future, while bonds pay their yields up front. The higher the bond yield, the less willing stock investors are to wait on promised growth. Japan’s zero-rate policy is also keeping the yen cheap as investors sell the currency’s bonds to buy higher-yielding US ones.
Despite all this, the growth-value performance dichotomy persists in Japan. Through June 30, the MSCI Japan Growth Index is down 30% in US dollar terms versus the MSCI Japan Value Index’s 9.6% decline. That has hurt the growth-oriented T. Rowe Price Japan and Matthews Japan funds, which are down 31.5% and 28.8% in 2022, respectively. The value-oriented GMO-Usonian has declined 16%.
Unfortunately, the GMO fund is available only to institutional investors, while the other 10 active Japan mutual funds generally tilt toward growth. Yet there are value-oriented ETFs: iShares MSCI Japan Value (EWJV) and WisdomTree Japan SmallCap Dividend (DFJ), down 10.3% and 15.9%, respectively, this year. GMO’s Edwards points out that Japanese small-cap value stocks currently trade at a 43% discount to large-caps, when historically their discount has averaged 27%. Indeed, the WisdomTree ETF has a dirt-cheap average price/earnings ratio of eight for its portfolio, according to Morningstar—about half that of the S&P 500 index.
Growth stocks will eventually come back. But for now, cheaper export-oriented companies have been benefiting from the yen’s decline, which makes their goods more attractive to foreign buyers. “In this current market, some poor-quality [Japanese] exporters have seen their profit margins go from 2% to 5% because the currency has just been so weak,” says Hurley of the growth-oriented T. Rowe Price Japan fund. “That kind of environment has been a real challenge for us. But as the economy eventually settles down, it will be a much more supportive environment” for growth stocks.
Hurley points to a company like Keyence (6861.Japan)—an industrial sensor and scanner manufacturer down 33% in 2022—as a beneficiary of inflationary trends worldwide, calling it “one of the best factory-automation companies in the world.” Wage inflation and an aging workforce in developed nations will drive manufacturers to automate to cut costs and replace retiring workers, he argues.
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T. Rowe’s fund by design invests about 75% of its portfolio in growth companies and 25% in value turnaround plays. An example of the latter would be wireless company Nippon Telegraph & Telephone (9432.Japan), which trades for 12 times earnings and has been increasing its dividends after a corporate restructuring.
Other managers have been tweaking their portfolios to give them some more value exposure. They’re buying “growth stocks in disguise,” as manager Masakazu Takeda of Hennessy Japan (HJPNX) calls them. He likes Hitachi (6501.Japan), which has a P/E ratio of 11. “Hitachi is a century-old industrial conglomerate,” he observes. “It was a very poorly run enterprise up until 2008, when the financial crisis hit them hard.” The company later “got its act together” by shifting its business model away from hardware sales toward software and information technology.
Takeuchi likes Sony (SONY) for similar reasons. Investors think of it mainly as the hardware maker of PlayStation, but underappreciate the growth potential of its digital content at Sony Music and Sony Pictures, which owns the Spider-Man movie franchise.
“Digital [content] is the growth area globally across the world,” he says. “But Sony is still seen as a hardware company. So, it’s still trading at a meaningful discount, compared with the Disneys of the world.” Sony’s P/E is 16, and Walt Disney‘s
Both Sony and the yen could rally—two ways for US-based investors in Japan to win.
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